Wednesday, 10 June 2015

Hanging in The Trade Balance: Is Free Trade a Curse for Kazakhstan?

Published in Analytical Articles

By Sergei Gretsky (06/10/2015 issue of the CACI Analyst)

The creation of the Eurasian Economic Union (EEU) was presented as a vehicle for economic development of Belarus, Kazakhstan, and Russia as a result of the removal of barriers to free movement of goods, capital, and labor between the three states and creating a common market. Its inauguration on January 1, 2015, happened at a very inopportune moment as Russian economy, the largest of the three, was sharply contracting due to falling global commodity prices and western sanctions over Ukraine. Economic recession in Russia has had a negative ripple effect on Belarusian and Kazakhstani economies, which led some in Kazakhstan to second-guess the benefits of joining the EEU. 

BACKGROUND: Instead of the expected free flow of goods across the Kazakhstani-Russian border as of January 1, we got what many rushed to call a trade war between the two countries. Media has been full of stories about the seizure of tons of beef, poultry meat, milk, chocolate, and other foodstuffs crossing to Kazakhstan from Russia allegedly for “not meeting technical regulations.” Russia reciprocated by refusing to let tons of Kazakhstani cheese and other dairy products into Russia for “not meeting quality and safety requirements.” On March 5, a “temporary” ban on imports of Russian gasoline was put in place as President Nazarbayev invoked EEU regulations that allowed protective measures, such as temporary bans on imports, in exceptional cases. Curiously, the latter measure was taken despite the chronic shortage of gasoline in Kazakhstan. Kazakhstani businessmen representing other sectors of the economy are now advocating a ban on Russian imports.

The immediate explanation for this turn of events is the ruble’s depreciation by 47 percent against the tenge in 2014, resulting in a displacement of domestic products with significantly cheaper Russian imports. Though Kazakhstan’s National Bank anticipated the ruble devaluation and devalued the tenge in February 2014, it did so only by 19 percent and has so far resisted further devaluation. Some experts anticipate that the double-digit inflation in Russia will eventually close the price gap on the same goods between the two countries. This, however, has not yet happened and remains a hypothetical scenario. Meanwhile, Kazakhstan’s National Bank spends, according to the estimates of Moody’s Investors Service, US$ 2-3 billion per month to maintain the tenge’s current exchange rate, while Russian products continue to flood the country, pushing local producers out of the market.

A case in point is the automobile industry. In November 2013, construction began on a car factory in Ust-Kamenogorsk, a city near the Russian border, to produce 120,000 vehicles a year, three times the automobile production in the country. The decision to build the factory was based on the expectation that under the EEU free trade regime, car exports to Russia would bring windfall revenues. In 2014, Kazakhstan planned to assemble 60,000 cars, 50 percent more than in 2013. Instead, by January 2015, the official automobile market had contracted by 28.5 percent, with the share of domestically produced cars dropping by 62.2 percent. As a result, the market share of cars assembled in Kazakhstan is only 12 percent, compared to 62 percent for cars assembled in Russia.

This is a good illustration of the overall trade balance between the two countries. In January 2015, Russian imports to Kazakhstan increased by 7.3 percent year-on-year, while Kazakhstani exports to Russia dropped by 41.2 percent.

IMPLICATIONS: Is Russia – and Kazakhstan’s membership in the EEU – to blame for Kazakhstan’s negative trade balance with its northern neighbor and the current misfortunes of Kazakhstani manufacturers? Are Kazakhstani entrepreneurs right when they blame the EEU for creating unfair competition? It is instructive that within the same timeframe, Kazakhstan’s trade balance with other EEU members reflect similar dynamics. Kazakhstan’s imports of Belarusian and Armenian products have increased by 19.8 and 33.4 percent respectively, while Kazakhstan’s exports to Belarus dropped by 46.1 percent and to Armenia by much more than that. It is also telling that a 20 percent decline in Kazakhstan’s trade turnover with Russia and Belarus in 2014, which resulted in the negative trade balance, comes on the back of a 20 percent increase in Kazakhstan’s trade turnover with China.

It is clear that currency fluctuations can only partially explain Kazakhstan’s negative trade balance with Russia (and other EEU member-states). At issue is the fact that Kazakhstan has little to offer the outside world other than its natural resources, whose share of Kazakhstan’s exports has been consistently increasing. In 1995, the share of oil and metals in Kazakhstan’s total exports was 42.3 percent. In 2007, it was already 76.4 percent, and had by 2014 increased to 89.2 percent.

In this light, the main underlying cause of Kazakhstan’s negative trade balance with Russia and other EEU countries is the lack of economic diversification. Despite multiple programs adopted by the government to promote diversification, these have so far yielded no tangible results. Even in sectors where Kazakhstan could be expected to have a comparative advantage, such as oil and agriculture, one can observe a failure to create value-added products. Whereas 18 out of 25 million tons of crude oil were refined in Kazakhstan in 1991, only 14 out of 80 million tons are today. The country imports of up to 40 percent of its gasoline and other fuels from Russia. In fact, Kazakhstan’s membership in the EEU, and the Customs Union which preceded it, annually saves the country US$ 500 million in custom duties that otherwise would have been imposed. As for agriculture, Kazakhstan had a net-export of 180,000 tons of meat in 1990, but by 2011 had a net-import of 20,000 tons. The government set the goal of boosting export-oriented meat production in the country and to export 60,000 tons to Russia and other countries by 2014. Instead, it imported 7,500 tons from Ukraine in 2013.

Today, Kazakhstan imports over 90 percent of its consumption of powder milk, cheese, butter and other dairy products. The only success is in grain production, where Kazakhstan has become one of the world’s top ten grain producers and the number one flour exporter.

The lack of diversification is partially explained by the inaccessibility of bank loans for startup businesses, a problem that also hampers the growth of existing companies. Kazakhstan’s National Bank has enabled high interest rates on loans exacted by the banks by setting a ceiling at 56 percent annually in 2012. As a result, the real sector of the economy avoids banks and looks elsewhere to fund its operation and growth. Only 22 to 24 percent of companies, particularly small and medium-sized enterprises, seek bank loans whereas the rest resort to self-financing. High interest rates on bank loans and a lack of capital to finance the expansion of existing companies, which would have enabled them to achieve economies of scale, explains why Kazakhstani products are both expensive and priced out of the market at the slightest change of regional or global terms of trade.

CONCLUSIONS: The current predicament of Kazakhstan’s negative trade balance with Russia (and other EEU members) is self-inflicted. Complaints by Kazakhstani producers that they are priced out of the domestic market by cheaper Russian imports should be directed not against the EEU, but economic policies of their own government. The same complaints were heard from the same producers during the 2008-2010 global financial and economic crisis. Yet little has been done to increase the competitiveness of Kazakhstani products and to avoid their displacement by cheaper imports. Until the country takes effective steps to diversify its economy away from reliance on the extraction of its mineral resources, it is bound to repeatedly experience negative trade balances. This is valid for any free trade agreement that Kazakhstan has committed to, and will occur at the slightest change in the terms of trade (as measured by the effect of the decline in raw material and agricultural prices on the difference between exports and imports). In this sense, Kazakhstan’s membership in any free trade economic block, be it the EEU or WTO, will indeed have a negative impact on its domestic producers in non-extractive sectors. WTO agreements do not cover oil and other mineral resources, which compose about 90 percent of Kazakhstan’s exports. Therefore, the only benefit for Kazakhstan, which liberalized its trade policy well before its accession to the EEU and pending accession to the WTO in 2015, is cheap imports.

AUTHOR’S BIO: Dr. Sergei Gretsky is a Lecturer at the Department of Politics, The Catholic University of America.

Image Attribution: Scott Sutherland & Wikimedia Commons


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