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Diagnosis For Whimperers
At the end of February, for the second time, analysts have gathered in the “Exclusive” club to discuss today’s situation of the financial sector and opportunities to influence it. Karlygash Ezhenova, Chief Editor of the “Exclusive” magazine, Ekaterina Kartseva, Deputy Chairman of the Board of Directors of “UNICORN” IFC, Nikolay Andrianov, Analyst of the named company, Dosym Satpayev, Expert of the CRMEK, Yuriy Khramtsov, Economist of Visor Capital, Igor Romanenko, Director of Treasury Department of the “Caspian” Bank, Hose Carlos Pinot Tirado, Attaché of the Embassy of Spain and Yerbol Sigayev, Associated Professor of KBTU, Doctor of Economics have participated in this discussion.
Karlygash Ezhenova:
The “Exclusive” club has been existing for over two years. It was planned and began acting as a Top-managers’ club. We gathered and discussed some problems. And now it is evident that these were not only talks. These meetings turned out to be very effective. The Analytical Center for Research and Monitoring of Economy of Kazakhstan (CRMEK) has become a progeny of the club. Recently a research of the current financial situation in the country was prepared with the efforts of this Center. A letter, based on the result of the research was directed by us to the Head of State. The President redirected this letter to the Prime-minister and Ministry of Economy and Budget Planning. The meeting, on this matter, with participation of a special working group of the government and CRMEK will be held next week. This is an example of the official reaction on the initiatives, which we put forward. The other question is whether these recommendations would be taken into the consideration or not. But the good sign is that they were considered by people, who are responsible for making decisions.
The Eurasian Club of Bankers was established a few months ago practically on the same base as CRMEK, but already with participation of intergovernmental structures. Last year we have also published a book “Economy of Independent Kazakhstan: History of Market Reforms” written by Professor Arystan Esentugelov; of which you have probably heard about.
Meetings of shareholders of large companies and representatives of state structures are held in the framework of the “Exclusive” club. If before these meeting were open, now, upon the request of its participants, these meetings are held in the closed format, i.e. in the narrow circles. The top managers of banks and companies are more open for discussions. In the nearest future we are planning to meet with them in this hall to discuss some aspects of the Presidential letter. Since these are issues directly related to the financial sector, we would also like to invite the representatives of AFN and National Bank to participate in this meeting.
In general, we plan to develop various, so-called, professional sub-clubs. For example, recently we held a meeting with lawyers (please refer to “Excusive” №3, 2008, - editor.), who have warmly supported this idea; that’s to say, the legal subdivision of our club has been already formed. And today we hold the second meeting of the analysts’ club and I give floor to permanent participant of our discussions, Yekaterina Kartseva.
Yekaterina Kartseva:
We have gathered here to share professional opinion on economic issues, specifically, financial ones. I consider our club as a good platform for development of recommendations. Whereas, the main concern is then to bring these recommendations to institutions, which make decisions.
Today we would like to present our main conclusions on the situation, which occurred in the second half of last year, as well as to express personal views on its further development and possible solutions to these problems. We hope to hear your opinions and your position on situation, your forecasts and suggestions.
Now, I would like to give a floor to our analyst Nikolay Andriyanov, who directly participated in conduct of the research.
Nikolay Andriyanov:
I think that the work that we completed could not be considered as a research. These were just small comments on issues, which began taking place in Kazakhstan, beginning from July of last year. We have tried to look at the economy of Kazakhstan, so to say, from the distance, or to push aside even more, so to observe only relieves and landscapes. In other words, initially, we did not plan to go into details.
From our point of view, a certain downturn of economic growth took place in Kazakhstan. First of all, it has reflected in abbreviation of the monetary component of this growth.
What is the reason for that?
The first reason is the international crises of liquidity caused by the fact that the quality of subprime loans in USA began decreasing dramatically. Many companies actively acting in the financial market had enough instruments at their disposal (including derivative instruments), which were tied to the quality of these loans. When the quality of loans has decreased and correspondingly, the price of such instruments quickly lowered, companies have started to suffer losses.
What did it lead to?
It led to the situation, where the volatility in the international market started increasing., which correspondingly, led to the increased risks for the investors. The first reaction of foreign investors in similar situations is to drawn back the money from the most risky markets. Such markets are considered to be so-called emerging markets, i.e. the markets of developing countries, including the Kazakhstan market.
On this background we have witnessed a powerful outflow of liquidity from Kazakhstan. It was foreign money, and banks began to experience difficulties in servicing short-term obligations without them. Eventhough, the National Bank had enough reserves to help them to serve those short-term obligations, as a whole, all of this pointed out the fact that beginning from 2002 Kazakhstan grew not because of the accumulation of fundamental factors. The dramatic accumulation of liquidity attracted on the international markets and high pace of oil prices increase led to the formation of the domestic monetary agonies.
We grew owing to dramatic increase of money aggregates. Therefore, the investors began to invest money in alternative highly profitable operations, i.e. immovable property operations.
With liquidity deficit, all operations on such markets, as to say, the immovable property market, have stopped. And we immediately saw the splash of inflation because all the liquidity which was in the immovable property sector had partially splashed out to the consumer services sector. Well, of course it is a hypothesis. It may be disputed, but it is our opinion.
Why did such situation occur?
The first reason is that the bank sector has significantly dominated the country’s economy. This was evident from the growth rate of money aggregates and credit mass. At the same time, the banking system itself greatly depended on international markets.
Secondly, such factor as low labor productivity, which has also an influence on the growth of economy. Activities, which took place before could be considered as the monetary growth ensured by the growth of the immovable property market, which, recently, took a comparatively bigger share of GDP. Based on our estimations, nearly 3-3,5% of GDP growth was provided by the increase in the immovable property market. In the conditions, when financial proposal had reduced, these 3-3,5% were automatically wiped out of this growth.
How will the situation develop?
Currently, in our opinion, stability of the banking sector will directly depend on stability of its credit portfolio. If the credit portfolio is stable and the consolidation of assets takes place, then banks would be able to serve short-term foreign loans. Certainly, the banks would be gradually compressed in size, but it would not lead to credit crises.
It is important to state, that the changes of the credit portfolio structure quality cannot be traced now, because the AFN has always been introducing and recurrently continue to introduce many changes in regards with classification of assets in accordance to their quality. But the retrospective re-count of statistic data in correspondence with the new standards was not conducted, and the comparison of data calculated in accordance with different standards would not be correct. For example, if we take statistics at the beginning of 2006 and the end of the third quarter of 2007, then we would see that the share of standard credits in aggregated loan portfolio of banks has reduced by 10%. Yet, this has occurred not because of the fact that the quality of credits had become worse indeed, but because of introduction of new standards of registering by AFN.
Besides, there is a certain verge of confidence between banks and AFN. It is delicate enough and does not let the AFN to exactly monitor credits from the point of view of their affiliation.
This is our short resume.
I would like to hear your commentaries.
Karlygash Ezhenova:
I absolutely agree with what you’d just said. I suggest to expand our attitude to reality. In my opinion, you look at the financial sector in isolation from the whole economy of Kazakhstan, as some integral system. I think that this is the over-all problem of the existing commentary, and it is in no way coordinated neither with macroeconomic tendency, nor with micro-economy. It needs to be understood the tendencies in the processing sector, agriculture, or in light industry. I fully understand that this is a difficult task, but nevertheless, in this discussion, I would like to expand over the boundaries of financial sector only. Now everybody talks much about financial sector, but nobody tells how it has influenced and how it will influence the activities country from the perspectives of balance of payments, of export, of import and of all the other indexes .
If we look at this situation in a different way, then we may not reproach the banking sector for its rapidly growth. Similarly, we cannot reproach a man for his quick professional development, when somebody develops slowly.
Yuriy Khramtsov:
I do not fully agree with that the banks could not be blamed for. The matter of fact is that if higher requirements were applied to borrowers, then the today’s situation would be different. Let’s, for example, look at the building industry. What do the building companies expect to? They expect to sell the immovable property, which is currently under the construction, at the price of $3000 per one square meter. But this is impossible to do! Let’s say that the building companies have made mistakes in their estimations. But the question is why the banking analysts have agreed with such estimations and took them into consideration?
Karlygash Esenova:
It is the market price.
Yuriy Khramtsov:
But we had to investigate, what if 60-70% of bargains are speculations or re-sales. What will it lead to? As to the data of the National Agency on Statistics, the average salary in Almaty is $700 US Dollars. How can we account for that at such average salary, 5 mln. sq. meters of accommodation at the price of more than $3.000 per sq. meter in the city may be sold?
I would like to hear the explanations, because of what reasons the immovable property market is actually frozen now, if everything was so successful? In my opinion, the problem is in the fact that the speculative component in the whole volume of trade with immovable property was colossal. As soon as the prices became unreasonable, the profiteers stopped buying up square meters. And here the problems with liquidity of banks were added, no mortgages, correspondingly, prices for immovable quickly went down. Who is to blame?
Karlygash Ezhenova:
The state had to trace the situation on the market and at least, had to apply regulation.
Yuriy Khramtsov:
Banks and private companies themselves have born the risks in regards with the crediting of construction and operations with immovable property. They made money on lending money on the security of immovable property. Why does the state have to undertake such risks now, if banks have observed unreal plans of building companies?
Karlygash Ezhenova:
We, analysts, are to blame. We acted incorrectly. We did not inform our managers and top-managers that in half a year the situation in the country would turn to worth.
The Center of Research and Monitoring of Economy of Kazakhstan was created specifically to provide forecast of such situations in a timely manner. Everything has commenced when a group of analysts has made an economic forecast and the forecast of the investment risks. We have gathered several companies and informed them about the forthcoming problems, and that there is necessity to prepare for them. It turned out to be that the market needs serious economic researches, and we have opened the CRMEK.
Khose Carlos Pino Tirado:
We have the same situation. There was period of time when prices for immovable property have grown rapidly, 13-20% a year, and who is to blame it? All were to blame. The profiteers sold at such expensive rates because there were people willing to buy at such high price. There were many people, who wanted to have an apartment and took low percentage mortgages. But most of them took mortgage for 50 years. And now, when the percentage at the mortgage is not 2.5%, but more than 5%, many people want to sell the immovable property, but there aren’t many buyers. Thus, with no demand on property, building companies do not work. This is what happens to the profiteers market.
Yuriy Khramtsov:
I do not think that the free market is something that all people have to try to reach; everything has to be regulated, whereas the level of such regulations –is the key issue. I believe, that namely through regulation the state de-facto sets priorities for the development of society. If the priorities are determined after the evaluation of all side, then the society would develop progressively, evenly, and not in the self-destroying trend. And if the priorities are not determined or traced, then there is a possibility of some distortions.
Partially, the lack of detailed information may lead the country into the regulated condition. In this case too many people begin to think based on invented categories. This lead to the development of balloons. The well informed, certainly comprehend what happen, but it is specifically them, who are least interested in the opening up of the information, because of them profiting from others of not being informed. An independent party – namely the state, has to foresee such situations and interfere them. Moreover, in my opinion, the increase of awareness, and the requirement for the openness of the information – is rather the alternative to the strengthening of regulation.
The accessibility of the information also contributes to the competition because it informs, for example, new potential producers of goods and services about the surplus profits that take place at the moment. The introduction of new participants has to increase the competition and to lower the surplus profits of existing producers. Again, if we trace joint plans and intentions, then the banks could avoid such issues as when the price, at which their clients could really sell products in the planned volume, and within the reasonable time period, at the price lower than it’s factual cost price. In this case, for example, the developers/builders would be able to find less costly ways and would not waste money, but would fight with extortions, which they like to plead as one of the factors of exaggerating of cost price, and would not encourage it. However, in this case, as well, the reliable detailed information on the structure of the developers’ expenditures is needed. Here one cannot but avoid mandatory audit, because the authenticity of the given data has to be checked by some parties. As we could see, again the lack of information plays an important role. In my view, part of the State’s efforts has to be directed to the improvement of the sphere of information strategies.
Certainly, it is difficult for a limited number of people to trace everything. But if we demand the publicity of the information and later publish it in the analyzed form for the wide circle of experts, or even better, for all the interested to get acquainted with it, make it accessible for those very shareholders, (who are the co-investors, - meaning that they have right to receive such kind of information), then many uncertainties for the participants of the same market would become evident And there wide opportunities for nowadays information systems to make this happen. I think that the closeness, and, frequently, the lack of information for the reason of unwillingness to gather the detailed information, played a crucial role in the fact that none of the parties, interested in high prices expected decrease of demand on immovable property.
Khose Carlos Piro Tirado:
As far as it concerns with prices, then we have the forecast for 5 years. Nobody paid attention to it, because there was too much money in the market.
Dosym Satpayev:
Everything rests on the effectiveness of the managing system. I recall Bulat Zhamshiev’s recent statement criticizing “Kazyna”, when he literally blamed SDF in the fact that the programs for rescuing the building segment, small and medium business, appeared to be incorrect. But $4 billions were already determined as a ring-buoy. It means that our government first takes decisions, without thinking about the consequences, and then, immediately, suggests other options. Thereafter this mess leads to search for guilty. This is a traditional occupation of officials. Our state has always been the monopolist, as in taking decisions, so in the sphere of control over their implementation. And now, this monopoly becomes even stronger. If to proceed from the fact that the process of formation of state capitalism is taking place in Kazakhstan, which is characterized by intensive influence of state structures in one or other segments of economy, then everything looks more or less logical. They started from the national companies under the state control, having joined them under the roof of “Samruk”, and then established the SDF “Kazyna”, and development institutes, which began competing more with the commercial structures, than pushing the economy forward. Now they decided to take up the banking system. Coming to the point, now the state has specified the issues that it has notified in advance to the second level banks last year. At that time the National Bank and AFN have began to strengthen their control over the process of foreign borrowings on the part of the second-level banks. But, in spite of this, they have missed the crises. Now they passed to the next stage. Though who has said that our state is a good manager? Let’s take, as an example, the statement of the Ministry of Finance on the fact that the sum of the unused republican budget for the year of 2007 equaled to 26 bln. tenge. In the local budgets the situation is the analogues. If our officials cannot spend money reasonably, then how on earth we can await that they will earn them wisely, having no resources. Such a feeling appear, that the talks about the increase of the state’s role in the activity of the banking system of Kazakhstan may conceal concrete interests of definite groups to start redistribution of spheres of influence in this very segment of the Kazakh economy. Moreover, the cases had already taken place with the same “Nauryz Bank” or with “ValutTranzitBank”.
But I, as a person concerned with political studies, am more afraid of the fact that all their unprofessional efforts will be reflected on the political situation of the country. The thing is that the middle class, which has just begun to grow at the expense of small and medium business, would be reduced. Where would these people go? We have called them “new poor”. These are the people who have already felt amenities of the consumer paradise. And now the state, by its actions levels them down to the lower social stage. This leads to the social unrest, and it would rise, because a new category of “less provided” category of people will be added to the “old poor” It is a cautious situation. We wrote about it in the analytical report, which we have presented to the representatives of the banking system in last May.
Yerbol Sigayev:
We’d like to know from the representatives of the “Unicorn IFC” for whom and with what purpose we made this report? Whether there are any concrete conclusions and decisions that have been presented in this work?
Nicolay Andriyanov:
If to talk about forecasts, then we base them on the fact that the situation in Kazakhstan would on the whole follow the situation on the world market, because until now we do not have any protection from the world economic processes. The only long-term solution to the problem is the acceleration of the real infrastructure reforms.
For the time being we see that the building sector is being concentrated on the construction of the elite housing and business centers, and not on the infrastructure development, i.e. not on the construction of roads and other communication means. If this long-term component of the growth based on the other short-term factors would be missing, then, correspondingly, sooner or later, the growth would come to an end
What was the growth of GDP in 2000-2007? What have we created for the further fundamental growth of economic? Everybody wanted to find in that growing economy, in the growing money those very projects that would cover their cost maximally quickly and would be profitable in the long-term perspective.
What type of projects were they? They were the projects that were able in the maximally short term to eat up the extra liquidity, which has been constantly accumulated in the economy.
Naturally, none of the infrastructure projects, which had a long-term structure of self-compensation, would satisfy the aforesaid criteria. And since people had the monetary illusion, then the economic risks were apprehended not at the corresponding positional level, at which they had to be apprehended.
Karlygash Ezhenova:
We can present our recommendations to AFN or National Bank, and it seems to me that we have to invite the representatives of the analogous analytical structures from the other branches of economy, such as, for example, from the oil industry.
Our problems lie in the fact that we constantly stew in our own juice. The investment companies stew in their own juice, banks - stew in their own juice, and so on. It seems that the problem lies in the communication, at that it has intensified when the majority of state structures and national companies have moved to Astana.
When I arrive to Astana, I meet with people who work there; they ask me why we do not invite them to the club’s sittings, about which they often read in our magazine. People from the Ministries ask us to invite them to the meetings because they lack the information.
We would like to hear your opinions on the question of how real is it to create a separate section, a really functioning group for analysts, in our club. If it is real, then which form this section may take? A month ago, for example, lawyers met here, and it turned out that they have a plenty of common questions, which could be solved with the club’s assistance. Thereafter we could have held some joint sessions say, once a quarter.
Igor Romanenko:
I would like to return to the question on the state regulation of market. As for me, to reproach the system of the state management in its ineffectiveness – are the topic for the poor people. Dosym Asylbekovich (Satpayev – edit.) has correctly noted that the state would never make an effective manager.
Financial Times has recently published an article under the headline, which literally could be translated as, “Stop Being the Whimperers of First Instance». In economy there is a term «the last instance creditor”, when there is nobody to address to, and they go to the Central Bank. Nowadays, when in the world there is a slightest hint to crises, they began to address the governmental structures. In other words, business begins to behave itself as the whisperers of the first level. If you lead a risky strategy – then you have to respond to it. If not – then the Central Bank will support you. This is the only way. If every time we mobilize the whole state structure to support business, then we would not be able to build an effective market economy. It will not be so, until the matured people begin to undertake the responsibility for their own deeds. I am not against your opinion on the ineffectiveness of the state management. But to make the market become more effective, it has to grow itself, it takes time.
It is not an accidental that the accent is made on the financial sector. If you compare the volume of financial markets with the volume of the world economy, with the real GPD, then you would see that it will overstep not in few, but in tens of times. From this perspective, the importance of decisions that are taken in the financial sector, the same times higher than it is in the other sectors.
As far as it is concerned with the inflation, then the growth of prices for commodities – the basic raw material, which are being used, say, in the production of foodstuffs – have made up on the world market from 50% up to 70%. Since we do not have a ban on export, producers would try to export the raw material at higher prices, naturally, the cost of say, the grain in the country would also rise. It is already the second question why the prices for trade and commercial activities did rise. It seems to me that the drivers of the process are investment and speculator trends on the financial markets. The market of trade futures is considered by larger number of investors as an opportunity to earn, and as well as the capitalization of the given market is comparatively small, and when a big investment fund comes and invests several billion dollars or euros, then the price for this or that commodity immediately grows at 5-10%. From here the prices for the finished foodstuffs, as well as the 5-10% are retranslated along the world economy. The main part of the inflation was imported or depended on the export.
As far as the uniqueness of Kazakhstan is concerned, I partially do not agree with Nikolai on the fact that the crises was generated by the common world problems, and that Kazakhstan in future would strongly depend on the international financial markets. The investors “run away” from the developing markets, but not from all of them. Within the same period of time the stocks, for example, of Chinese and Indian companies grew at 30-50 % and direct investments into the economies of these countries have increased. If many people already do not apprehend Russia, China or India as the “developing” markets, then the given example will not seem to You as a correct one; let’s take as an example Ghana or Gabon – their bonds during the crises stayed on the same level and even went higher because of the fact that their economies were not integrated into the common world market. The investors, on the contrary, used these instruments as “a safety harbor” for their capitals.
If there would not have been a crisis, which nowadays has expanded on the world markets, then the satiety of the world investors by the Kazakh risks in any way would lead to the decrease of demands for our instruments. Money entered into the national economy through the Kazakh issuers, (80% out of which are banks). The satiety of the world investors by the Kazakh risks was noticeable on the market already a few years ago, and it has displayed at the time when the credit risk on the other world market went down, and the credit spreads narrowed down, prices for the Kazakh instruments stayed at their best stable, at their worse began to fall down, indicating the satisfaction of the investors. Everybody understood that such a small economic could not generate so many instruments and attract so much capital. These risks were simply incomparable.
Here is a simple example of how the attitude of investors to our issues started changing. The story was told by one of the representatives of the western banks - underwriters, concerned with the investment of the Kazakh banks bonds on the external markets. Once the Kazakhstan bank comes to him and states that it would like to attract 200 million of dollars from the external markets. The underwriter collects the investors’ applications and finds out that, there were applications for not 200 million, but for 300 million. It means that there was a comparatively bigger demand of these instruments; correspondingly, the placement could be hold at the lower prices. In such cases the loan taker, as a rule, receives the same 200 million, but “pushes” the cost price of the placement upwards.
The Kazakh banks did not move the price, but “took 300 million». In a week the underwriter calls back to say that the applications gathered for the 500 million. Our banks say: “OK. We would take 500 million». Thus, the investors had developed the impression that the loan-taker does not have any specific strategy, on which the money is taken. They are loaned because they are loaned; we would take as much loans as you give. For the same reason, blames in regards to the management of risks in the banking system do not worth underestimation. The larger part of the fault for the current crises lies on the banks.
As far as it concerns with the influence of the crisis on the social situation, it seems to me that it is enough for the government to render the addressed support to the socially vulnerable layers of population. It may be done in different ways, in the form of “pay”- checks, as it is in the USA, or in the form of some other subsidies for the housing acquisition, or in some other way. The main issue - is to prevent the spreading of social consequences of the crises, whereas the market would reestablish itself, which only takes time.
