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Mikhail Sergeyevich Gorbachev

Mikhail Sergeyevich GorbachevGorbachev

Oil boom in Kazakhstan…What’s next? The Dutch Disease?
Astana, the new capital of Kazakhstan. Built with the oil billions.

Since its declaration of independence in 1991, Kazakhstan has witnessed significant economic development. This trend has accelerated recently since the 2000 with the discovery of oil and natural gas in the Kazakh sector of the Caspian Sea. Is the recent discovery a blessing or a curse for Kazakhstan? An analysis by Roy Yu

Kazakhstan never really saw itself as one of the “five Stans,” a term coined by the Western countries to describe the five former Soviet republics in Central Asia for convenience’s sake. In the mind of the Kazakhs, and especially of the Kazakh President Nursultan Nazarbaev, their oil-abundant country is simply too different from its neighboring republics.

A player from a different league

This sense of economic superiority also transcends into the political arena. As the wave of color revolutions swept through former Soviet republics, when the government of the neighboring country Kyrgyzstan was overthrown in 2005, Nazarbaev simply said that his country was too rich for a revolution. Despite the fact that he has been ruling the country since its independence as a de facto dictator, the Kazakhs love him and his accomplishments.

Nazarbaev and the Kazakhs should be proud. With the recent oil boom, since 1999, the economic growth rate is at a high annual ten percent. The country has gone through significant market reforms and economic restructuring. When it still was a republic within the Soviet Union, Kazakhstan had a state-controlled economy that was mainly agrarian and provided raw materials to Moscow. Since its independence, it has focused greatly on the energy sector as well as economic diversification, price liberalization, and privatization of former state-owned companies. With an oil production three times of that of France, it is anticipated to triple in 2015, which will put the country on par with Venezuela. According to the World Bank, the oil industry generated 30 percent of the total government revenues in 2004. Half of the country export earning depends on its oil industry.

The curse of the oil boom?

Bayterek Tower in the center of Astana

But, there is also a series of challenges that still lie ahead for this emerging oil-superpower. What to do with all this income generated by the boom? If poorly managed, this blessing can quickly turn into the Dutch disease, which will then have grave impact on the Kazakh economy.

The term Dutch disease is no stranger to Kazakh politicians and economists. The term, coined by The Economist in 1977, is to describe the phenomenon where a country experiences a slower economic growth despite its abundant natural resources as compared to countries that do not have this privilege.

The mechanism behind it is that when a country experiences a resource boom, it automatically attracts foreign investment. With a large inflow of hard foreign currency, the national currency will also appreciate. The adverse effect of this, however, is that it will make the domestic good less competitive in comparison with foreign goods, which then translates into a drop in export and rise in import. In another word, an ignored blessing can be easily transformed into a curse.

A problem in Kazakhstan?

The Kazakh government has already recognized this problem. The question is, however, whether the government has used the oil revenue to the greatest benefit of the country and, most importantly, to avoid the Dutch disease. How much money should be spent now and how much money should be spent in the future? The key is to find the golden mean and maintain a perfect balance. The prices of natural resources, and especially, oil, are volatile. If too much is spent now and the price of oil drops, the Kazakh economy will, no doubt, fall into an economic depression. While the oil price is still high, if a large sum of the oil revenue is poured into the economy, the prices of the domestic products will increase, which will then have an adverse effect on import and export. Inflation, in this case, will also not be a surprise.

Looking closely at the economic development of Kazakhstan and the current implemented policies, there are no great signs of Dutch disease. The economy has first benefited by the devaluation of Tenge, the national currency, in late 1990s. This enabled the Kazakh currency and economy to have great room of appreciation and growth. A low starting point for the Tenge also gave the domestic industry a much-desired economic competitiveness ensuring that the export revenues still remain strong as the oil sector booms.

The Kazakh solution

The Kazakh government has, in fact, poured millions of oil revenue into the country’s infrastructure, namely the change of the country’s capital from Almaty to Astana and the city planning and development that followed. Nonetheless, in the early stage of this oil boom, in 2001, the Kazakh government and central bank created the National Fund of the Republic of Kazakhstan. With the creation of savings and foreign saving bonds, the Kazakh government is to save up parts of the revenues and use them for a later day. A smart move indeed, considering the volatility of the oil price.

Joining the anticorruption program established by former British Prime Minister Tony Blair, Extractive Industries Transparency Initiative, the Kazakh government has won the hearts of its people, if not in practice, at least in name. In Kazakhstan, a significant amount of this oil revenue also went to the establishment of the health care system. New apartment buildings are on the rise while the old slum houses are being demolished. With more schools being built, the literacy rate is also increasing. The oil revenue has, in fact, bought people’s loyalty and this is why Nazarbaev claimed his country is too rich for a revolution.

But what if the oil depletes or the price of oil drops? Kazakhstan has already thought ahead of the game and prepared the backup plan. Unlike another former Soviet republic, Azerbaijan, who is also currently experiencing an oil boom, Kazakhstan has diversified its economy. Whereas Azerbaijan focuses solely on oil production, Kazakhstan has also placed emphasis on its agricultural and textile industries, while oil production remains the principle driving force of its economy. This economic diversification is a great cure for the Dutch disease. Worse comes to worst, if one sector fails, there will be others.

What’s next in Kazakhstan?

It is clear that, at the moment, the Dutch disease is not immediate, if the Kazakh government continues to implement these current policies. However, since the initial devaluation of Tenge in the late 1990s, the country has witnessed an appreciating national currency. Therefore, in order to fully eliminate the threat of the Dutch disease, the Kazakh government should tighten its monetary policy and the National Bank should quickly reduce liquidity in order to slow down the pace of credit expansion and contain possible inflation.