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BUSINESS AND SCIENCE: MARRIAGE FOR MONEY

Presentation of the Republic of Kazakhstan Economic Research and Monitoring Center (KEMRC) has been made at another regular meeting of the Exclusive club. The editorial staff of the Exclusive magazine had been an initiator of this idea. Professor Arystan Yesentugelov, scientific supervisor and director of KERMC presents herein the findings of his latest economic research performed as the first project of the center. The participants of the discussion were: Anvar Saidenov, chairman of the National Bank of Kazakhstan (NBK), Serik Akhanov, chairman of the Financiers Association (FA), Raimbek Batalov, chairman of the board of the Forum of Entrepreneurs of Kazakhstan (FEK), Sofia Aisagaliyeva, executive director of the Entrepreneurs’ Forum (EF), Nurlan Smagulov, president of Astana Motors Company, Saduakas Mameshtegi, chairman of the board of Bank TuranAlem JSC (BTA), Tamara Omarova, chairman of the board of directors of First Investment Company, Bakhytzhan Sarsekeyev, deputy chairman of the board of directors of the Center of Market and Analytical Research (CMAR), Murat Yuldashev, chairman of the board of Temir Bank, Timur Zhaksylykov, general director of the Economic Research Institute (ERI), Dimitri Zherebyatev, chairman of the board of directors of Centras Securities Company, Oleg Khe, chief editor of “Bisness i Vlast” (“Business and Power”) newspaper, Irina Musayeva, president of the Public Foundation for Mass Media Support (MMS), as well as other members and guests of the club.

Karlygash Yezhenova:
- We are having another meeting of the Exclusive club after a short summer break. For those of you who are not familiar with the group, please allow me to elaborate – the Exclusive Club is a gathering of senior managers. We discuss here very important issues in as informal an environment as possible. Creation of KERMC is one of the results of our discussions. Today we would like to present to you the first work of the center, which de jure is not [officially] established yet. Currently, the project is in the preparatory stages, but I hope our presentation will encourage you to render organizational and moral support, [and] maybe even financial assistance. But, first of all helping us to make KERMC effective. We have discussed this issue several times, and everybody agreed the idea was necessary and timely. Even if we have analytical and market research centers and economic institutes in the country, I believe we can co-exist on the market. Research will begin in two stages. The first, which we will talk about today, includes macroeconomic and fundamental research, as well as that of interest to all markets; everything related to marketing, field research, customs policy, tax policy, and so forth. The second stage of research is what we are going to live on – this is bipartite research, which we will carry out by participating in tenders and competitions, trying to win or to receive an offer for performing concrete research. Raimbek Batalov is one of those who actively supported the idea. This is why he can tell us a little bit about it.

Raimbek Batalov:
- The current objectives of KERMC’s activities have been highlighted by Karlygash in detail. What I want to say is that the establishment of this center is very necessary, as nowadays there is a lack of independent economic research. There have been some ideas, but it is absolutely important to back them up with substance. Throughout this forum, we have been facing the fact that statistical data alone provides an insufficient basis for working out effective proposals on either legislative acts, [inclusive of] other normative and legal documents, or for [industrial] branch problems as a whole. This is why I believe that the idea is sound. KERMC has already conducted its first research project, though unofficially, yet this is a definite step forward. I would indeed like these mechanisms to start working, especially as Club members can get a lot of things moving and may facilitate the center’s activities. Karlygash is right in saying that this project should be effective and helpful. Therefore, it is of primary importance that we efficiently utilize the findings of from this research, both for the sake of the business community and for the overall successful economic development of our country. This, to my mind, is one of our priority tasks. So far the development [of the center] is but in the initial stage, but I hope we are able to support this work.

Karlygash Yezhenova:
- Before Mr. Yesentugelov starts speaking, I would like to say that it is important our work be needed by the market. I am glad to see Messrs. Saidenov and Akhanov. I hope we will be able to collaborate and help each other. Please, keep in mind that you have this center as a reserve, and [can] utilize its services. Mr. Yesentugelov will be scientific supervisor and a director of KERMC. Our sponsors include several of the largest banks and companies in the country.

Arystan Yesentugelov:
- It is very hurtful [for me] to see the work of Russian scholars and research centers on our market. I think that the intellectual potential of Kazakhstani scholars is high enough to be able to do this job on our own. The existing Kazakhstani state institutions, one of which was under my purview for ten years, are now busy with complimentary publications, research and discussion of those high resolutions. These institutes, as my own experience tells me, could be of little help. Private institutions supported by business are what we need now. I would like to talk about the activities I have been busy with since 2003, when I was working in the capacity of [former Minister of Economy and Budget Planning] Kairat Kelimbetov’s advisor. I presented for the first time a macroeconomic research project with prognoses of expected Dutch disease, economic overheating, and the bubble that we face due to the active spending of money and profits [via consumption]. In 2004, I continued working on this issue and on March 31st I presented the research to the Prime Minister and ministry authorities. A working group and a group of experts were organized. This at least confirms that it [the research] was recognized. Today I am still working on this problem, though it is impossible to solve the problems of economic diversification and increasing competitiveness without macroeconomic stability. Moreover, the macroeconomic level [contribution] to our stability is far from that desired: this would include a low inflation rate, stable currency exchange, high GDP growth, and a low level of unemployment. You all know that in the course of a few years, beginning with 2004, the level of inflation in the country has been growing and the currency rate has been fluctuating. All this testifies to the fact that a threat to economic stability really exists. This is why scholars should now be busy following the situation. What are the conditions [needed] for our country to become competitive as soon as possible? The answer to the question of Kazakhstan’s [future] entrance into the top 50 [most competitive] countries I do not know. For me it is [simply] important that it becomes competitive. I would like to note the maxims of two famous scholars, to which I adhere: the first is [Joseph] Schumpeter, an economist of the 20th century who said, “An economist, apart from people writing on economic topics, should first of all know the history of economics; secondly, statistics; and thirdly, theory.” And a second economist, [Milton] Friedman, stated, “The science of economics should answer the following question: what is going on in the economy. And not the question about what it should be like, as to reveal what is happening is to foresee its development.” This is the reason I first of all deal with statistics. Why do we have a gradual upwards movement of inflation? This is primarily linked with the flow of capital. We know that every year the government and the Parliament discuss problems of inflation. And every year they try to find the guilty party: the NBK, businessmen, bankers, experts, importers, and so on. These fights take place each year, and then calm down when the Government sets the quota on the oil product delivery, a limit on the export, etc. But I believe, and have believed, that the basis of inflation is to be found in monetary phenomenon. Inflation appears where the money supply grows faster than the volume of the goods produced. The second chart shows that growth in capital essentially exceeds growth in the nominal GDP volume. During 1999-2005, nominal GDP grew 3.7 times, while the money supply increased by 7.5 times. Another indicator of inflation is money supply over the domestic price index. We had an average annual growth in prices of 8.4%, though money supply jumped by 33.4%, with cash [M1] by 22%. I want to add that the growth of inflation is not just caused the increase in money supply, but also by its sharp growth rate. Stability in growth rates is essential for retarding inflation. In which, as you can see, we have had a very big rise. It was natural that in 1999 inflation was 84.4%, which was caused by the introduction of a floating [currency] rate, and by an increase in the price for oil on the world market. Nevertheless, inflation has been fluctuating around high level for the past few years. Capital infusions into the economy have been transformed into credit that, in its turn, has also been higher than nominal GDP. Now, a credit boom is taking place and it is having a huge impact on the inflation rate. I want to turn your attention to the fact that we [Kazakhstan] seem to have a lot of money, but if a comparison is made between the growth in money supply and GDP per production unit, then the level of monetization of the economy is only 27%, whereas in developed countries this is between 60-100%. In Slovakia, Hungary, the Czech Republic and Poland the rate is around 60-70%. The next chart shows the level of monetization of the economy and the velocity (editor’s note: rate of turnover) of the money. Here we see that we have a small amount of money, and the real demand for it is high. Then why has the increase in money supply not provided subsequent growth in GDP, especially outside the natural resource sector, but instead heats up inflation? Research shows that the money we issue has not been transformed into GDP growth and by real demand in money [for investment purposes]. The reasons for this are numerous. Firstly, [Kazakhstan’s] GDP growth has been to a great extent the achievement of the natural resources sector. But, this is having no active effect on the domestic market for tenge [denominated contracts]. Kazakhstani orders account for only 8% of expenditures. Secondly, and primarily, there is no [growth in] business activity outside the natural resources sector and very low investment rates, by which I mean [through] private initiatives. The trouble is that a bad business and investment climate can be discerned in this sector. Therefore, basic expenditures here are made by the state sector. The third reason is that the interest rates on credit still remain at high, while productivity rates lag behind real wage growth. All summed up, everything presented thus far reduces the level of business activity and [effective] money consumption. Due to all this, a question arises: what could be done in this area in order to reduce inflation? The graph shows that volatility is very high. Although, when the NBK decreased the money supply in 2005, it still remained at a level of 25.2%, which exceeded the economy’s monetary needs by 8%. This demand can be summed up by two indicators: inflation and real GDP growth. In 2005, these numbers combined equaled 17%. But according to Friedman’s statement, size of growth is unimportant. What is important is that the growth rate was consistent and stable. However, monetary policy is not the only contributor to growth in inflation. The second component is fiscal policy. In 1999-2002 our financial authorities were implementing a responsible economic policy. Although the majority of oil revenues entered the national fund, changes in the money supply and forecast expenditures remained at a level of 21-22%, which was the same as in the period of 1996-1997. Unfortunately, since 2003 budget expenditures as a percentage of GDP have been sharply growing. In 2002 this was 23.2%, in 2004 – 23.9%, and in 2005 – 26.1%. The main issue as regards these expenses is the increase in capital expenditures within the state budget. They have also grown very fast, from 16.5% in 2002 up to 47.02% in 2005. Today this equals 7-8% of GDP. Budget expenditures are growing in two directions: capital expenses and numerous privileges, [being both] evident and hidden subsidies, [including] the development of free economic zones (FEZs) throughout the nation and various “techno parks” (editor’s note: these are industry-specific locales forming a part of the State Industrial and Innovation Program – SIIP, which focuses on the creation of “industrial clusters”, as propounded by the economist Michael Porter, and adopted by the Kazakhstani government). This naturally has an influence on inflation. How is it possible to establish so many techno parks and FEZs, and from where do the investment and innovational projects, as well as the trained personnel, originate? For example, in Taiwan, which has a population of 20 mln people, there is just one huge techno park. It is a whole city with its own citizens, laboratories, institutions, and so on. The same can be said of Japan. In our country nearly every city becomes a techno park. Many say that this is an international practice. Yet, it is not quite an international practice, [but] has been developed in certain Asian countries. We want to attain the European standard of living, yet have started to build the economy in an Asian way. Moreover, a FEZ is an economy [created] from a “transplanted organism” from the age of industrialization. Now, in the post-industrial period, from among the priority fields those related to high technology stand out, and they are given every possible tax and credit privilege, which are reflected in the prices [of the production]. This is especially in the areas of transportation and power. We keep saying that growth is taking place due to oil, yet I was surprised by the following straightforward calculation I made in 2002, which can be no coincidence: In considering oil exports as a share of GDP, then over 2000-2002 this was 18-19%, while in 2004-2005 it expanded to 30%. We could not understand why these divergences have taken place. The issue also, as it turned out, alarmed the staff of the World Bank, and so last year that organization conducted research using the example of the Russian economy. According to the calculations of the Department of Economic Policy under the Economy and Budget Planning Ministry, the multiplicative effect [on GDP] of 2.2 can be attributed to oil. If a calculation is done applying this multiplicative effect, then the contribution of oil to GDP is 20-23%. This means that out of the 9% GDP rise [in 2005], the oil sector supplied 4%. All this is distorted by the fact that we have large and undeserved costs added for transport in the energy and agricultural sectors, as well as in other branches of the economy. Development of high technology manufacturing projects, techno parks, and numerous innovation projects [has occurred]. In 2003, when a strategy for innovation and industrial development was being considered, we gathered together so many people from all the universities and institutes… from Kurchatov… from Stepnogorsk, and then there was not one innovative idea and not one innovative project. The [then] Prime Minister Imangali Tasmagambetov took the list and asked, “And where are the innovations here?” Though, today we have a lot of innovative projects. As international practice demonstrates, there are fewer successful than unsuccessful ones among them. According to survey data from the 200 managers of such companies, 67% noted either a total absence of results or their insignificance. This leads to the waste of enormous state funds and creates pressure on macroeconomic stability. This is why monetary and fiscal policies should coincide with each other. In my mind, the situation today is as follows: the NBK is striving for the reduction of inflation through its monetary and credit policy, while the fiscal policy of the government swells it. Taking as an example the experience of the U.S., Japan and China, economic overheating occurs because of such things. And economic laws have the same effects everywhere, in America, in Africa, and in Kazakhstan. Nobody can counter these laws. Excessive financing of the economy has been occurring, especially in the real estate sector. This area, in my opinion, has already overheated. The problem is acute in China, the U.S. and Russia, where very little real estate is being purchased on their markets. It is already being sold at a loss in the U.S. – this is overheating. It depends on us if such excesses result in a financial crisis or not. If we can use our controls in a timely manner, we can prevent this overheating from creating a financial crisis and economic recession. Based on this research, the following important points should be singled out. Firstly, we need to stabilize the rate of growth in money supply. Secondly, it is necessary to coordinate fiscal policy with macroeconomic stabilization. Last year, the budget deficit outside the oil industry was 5.1% of GDP, while today 3.1% has been forecast. However, on the one hand budget expenditures are increasing, and on the other there is a deficit. Overall, though, formally there is no deficit, as it is being financed with the oil revenues. This is very dangerous. Even the NBK’s efforts would not be able to manage such challenges, if fiscal policy goes another way. Fiscal policy should return to the 21-22% level, which we always previously maintained. 22% was the maximum during the normal period. The last two years (2004-2005) have literally provoked growth in fiscal policy. Stability is more important than money. Of course, we are fond of spending money, but then we will have to settle accounts: the economy may painfully decline and stay that way for a long time. Nobody has managed to escape the consequences of extravagantly wasting money. Thank you for your attention. I have covered the basic points that I felt to be the most important.

Karlygash Yezhenova:
- Thank you very much. It seems important for our participants to share their opinions, as we are creating the first private center of this kind and want to make a bridge between decision-makers and those who implement those decisions. This is why I want you, Mr. Saidenov, to comment, since you are one of those who makes decisions and implements them.

Anvar Saidenov:
- In general, I think we need to have such research. This is necessary since assessment of the macroeconomic situation of the country has been mainly done by state institutions. For example, the Ministry of Economy performs analyses of the situation in the country using different integrated techniques. The NBK uses various methods of analysis and modeling. However, the final findings converge – denying the obvious is difficult. We have discussed here the issue of a lack of coordination between the fiscal and the monetary and credit policies. This point has been mentioned in governmental documents. At the NBK during the last several years we have been pointing to the expansionary nature of budgetary policy, as it is really true that expenses as a portion of GDP are constantly growing. According to an analysis of the first six months [of the current year], this is still the tendency, even though the government is aware of the problem. Conversely, we have made the monetary and credit policy tougher this year, though representatives of financial institutions would agree that our latest measures have been constructive. We are trying to control liquidity in the market. The NBK has been freezing a great amount of commercial banks’ corresponding accounts. According to different estimates, about US$600 mln is being kept on account, which is not used by the banks, and does not bring any income. Such a discrepancy between the fiscal and the money and credit policies is quite a disadvantage. As regards medium-term fiscal policy, for the three-year period a decrease in the share of state expenditures as a share of GDP is expected. We shall see how this will come about. So far, these are big plans. I talked to my colleagues who worked in the NBK before, and they say that there are many people in the government who have not experienced a period of crisis, and have no understanding of the problem’s seriousness. However, if one looks at other countries’ histories, moving past problems is inevitable. If one has such [large] revenues, one can hardly avoid the temptation of spending this money, while the government could identify a more effective way to utilize it. Another issue is related to the [national] oil fund. I consider it to be a very important tool for stabilizing the macroeconomic situation. Knowing how the funds are to be spent is essential. Again, the government has forecast quite an amount of outlays for the three-year period, and is moving towards increasing the tendency. We cannot agree with this. We need to tightly control the size of spending. It has been suggested to represent it as a percent of GDP, but the government recognizes it as interest from the oil fund. Yet, even this approach is not appropriate. Personally I agree that it should be defined as GDP interest. But other analytical data, especially monetary aggregates [within the M1 and M2 money supply], and their dynamics over a fixed period of time is also important. There have been fluctuations [reaching] various peaks. For example, last year monetary aggregates increased at quite a slow rate, but this year we are back to 2004 levels, being incomparably different. Besides, there are many other issues that we face in our activity at the NBK. Case in point, the bank deposits that we accept are calculated as monetary aggregates and, moreover, these funds are removed from circulation. The same situation exists with funds in corresponding accounts, which are counted as reserves, though actually the correspondence accounts that are frozen are calculated as [part of the] money supply. I think this whole preliminary analysis of the situation is correct. Yet, if we look at some nuances, many details appear that must be taken into account. In general, according to discussions in the government and in the Council on Economic Policy there is an understanding of the problem. Everything is delivered to the President, and he considers applications of the oil or national funds very rationally. To some extent, the version of the budget that the government prepared has undergone some revision and reduction by the President. I believe that in some institutions they understand the necessity of such measures, and if we had a systematic and detailed analysis this would be welcomed.

Serik Akhanov:
- Thank you very much, dear colleagues. I have some comments. We support the creation of the independent private and analytical center. It will specialize on macroeconomic research, which is important since it must compete with the research department of our central bank. The researches of the center must be applicable. We need to define research topics taking into account the potential clients’ views. In Kazakhstan there is a unique model of a financial sector. We adapted the model of the banks in Germany, USA, and Japan. Loan system came from Malaysia, securities – from Italy, national fund system is taken from Norway, pension system from Chile. I would say we have a cocktail, and there is much work for scientists. And the most important thing is to keep in mind the structure of our economy. Financial organizations are interested in competitiveness of the processing sector. If to compare loan share as to GDP, at present it’s 41% and we are three times behind the European countries. They say that our external debt amounts to 73% as to GDP, out of which the banks owe 27% and our real sector and corporations – 46%. The issue of limits on the loans by the financial organizations rather than industrial corporations is questioned. Comparative analysis of the Central and East European countries showed a gap that must be researched. Our President repeatedly says that we need to develop the Eurasian integration. How could we maintain our economy with such a small internal market and without stimulating export? Could you name the segment that exports ready product with a high value added tax. We don’t have such segments. We have only the financial sector. It exports credits, financial technologies, management. This is the only sector that meets the international standards. We underestimate the role of the financial sector. For the country with a limited internal market the export would be the way out. For example, the South-East Asia exports cars, technologies and equipment. Specificity of Kazakhstan is in exporting financial technologies. This is a unique example and you would not find any other country. This is a big issue for scientific analysis and suggestions for our government. I would say that the topic of coordination of the monetary-fiscal policy is finally included in the document on the development of financial sector. The Ministry of Finance and the National Bank should coordinate their work. Here the National bank performs unusual functions, for example, it issues notes in order to save the financial stability. And the MinFin issues insufficient amount of securities. The pension sector is of the national social significance and should get financial instruments but it is short of it. Why the country does not have a securities market – this is another topic for a scientific analysis. This is a policy of the big joint-stock corporations. We want the scientific community support the civic duty of the financiers. We want to see the research findings of our scientists in the monographs, the letters to the government. Good luck. We look forward to seeing new books, researches and intellectual support.

Nurlan Smagulov:
- It was said that our business is not active. It’s true because the frames of the Kazakhstani private business are definitely limited: food industry, tourism, agriculture, construction business and financial sector- the only sectors that Kazakhstan can be proud of if to talk about private business. Steel, automotive industry, mining, oil sectors of industry are monopolized either by state bodies or transnational holdings. In this case it’s hardly possible to join efforts of Kazakhstani business and mega holdings due to objective reasons. This Center is necessary for saving transparent and civilized business for us – Kazakhstani businessmen who work in the free and highly competitive markets. I’d like to stress that at present we make decisions intuitively, without making any serious calculations and having any necessary data, without knowing the competitors’ plans, forecast of state of the market. Due to this negligence some economic sectors face “overheating”. Economists and experts are in themselves, “bumps” are apart. Majority of market players study the market empirically, by methods of trials and mistakes. The strongest ones survive: the public knows only leaders of the market but it does not know how many people lose everything and off screen (are behind). Taking into consideration the importance of this Center, we decided not only to be sponsors but participants as well. We would provide data, research findings that would mean our active collaboration. I vote for jointing of the business and science. I am glad that we are discussing this issue. We are all interested in analytical information, particularly in such fields as food industry, construction, hotel business, and retail business. There is a pile of cash assets, and the country undergoes overheating, businessmen move by touch, and this wave becomes the

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