Chapter 1. Foreign direct investment performance and Kazakhstan’s economic development

Recent FDI trends

Over the past ten years, FDI inflows have shown a strong cyclicality, reaching peaks in 2008 (of USD 14.3 billion) and 2011-12 (USD 14 billion) (Figure 1.5). After a fall in 2010, FDI has recuperated in 2011-12. Since then, however, FDI inflows in Kazakhstan have fallen sharply, primarily due to the reduced profitability of the domestic oil sector at lower oil prices but also reduced liquidity of firms in other sectors in the aftermath of the crisis. For example, in banking there have been departures of several large global players (see Box 1.1). Meanwhile, the outward FDI flows have remaining relatively flat, averaging USD 2.6 billion per year over the period 2005-15. The inward FDI stock in Kazakhstan has reached USD 119.8 billion (55% of GDP) and outward FDI stock USD 23.9 billion in 2015 (about one fifth of the inward stock or 11% of GDP). Kazakhstan is hence sustaining a net negative FDI position with annual FDI inflows outweighing outflows over the past ten years. The gap has narrowed in recent years with a relatively sharper decrease in FDI inflows than outflows in 2012-15.

Figure 1.5. Inward FDI stock and flows in Kazakhstan, 2005-15

Note: National Bank of Kazakhstan publishes FDI statistics according to the directional principle with a breakdown to countries and types of economic activities of the residents at http://nationalbank.kz.

Source: National Bank of Kazakhstan.

 https://doi.org/10.1787/888933452673

Box 1.1. Foreign divestments in the banking sector in Kazakhstan

Several global banks have divested their operations in Kazakhstan, partially or fully, in recent years (Table 1.1). Among the more notably ones was the exit from the country of UniCredit in 2013, HSBC in 2014, and RBS in 2015. In all cases, the assets were bought by Kazakh investors (see below). Foreign firms remain to be present in the sector though, with 16 out of all 35 banks having some foreign participation in 2015, including 13 subsidiary banks (see below).

M&A divestures in the commercial banking sector in Kazakhstan, 2005-15
Completion date	Acquiror nationality	Acquiror	Target	Divestor nationality	Divestor	Deal value (min USD)
24-Aug-06	Kazakhstan	QVT Financial LP	Bank TuranAlem OAO (7.7%)	Austria	Raiffeisen Zentralbank Oesterreich AG - RZB	174.8
31-Oct-05	Kazakhstan	Kazkommertsbank OAO	ABN AMRO Asset Management (Kazakhstan)	Netherlands	ABN AMRO Holding NV	-
13-Sep-10	UK	HSBC Holdings plc	RBS Group plc (Retail business, Kazakhstan)	UK	RBS Group plc	52
21-Feb-11	Kazakhstan	Eurasian Bank AO	ProstoKredit MKO	France	Société Générale	-
2-May-13	Kazakhstan	KazNitrogenGaz TOO-KNG	ATF Bank OAO (99.75%)	Italy	UniCredit SpA	470.3
2-Dec-14	Kazakhstan	AlmexHolding Group AO	HSBC Bank Kazakhstan	UK	HSBC Holdings plc	176
31-Mar-15	Kazakhstan	Capital Bank Kazakhstan AO	RBS Group plc (RBS’s business in Kazakhstan)	UK	RBS Group plc	-
31-Dec-15	Kazakhstan	Eurasian Bank AO	BankPozitivKazakhstan JSC	Israel	Bank Hapoalim BM	26

The reasons for the divestures of the foreign firms in the sector have been diverse but according to the official announcements appear to be driven by the long-term MNE strategies of focusing on the core markets of their operations and divesting peripheral assets. For example, the UniCredit’s decision to close its operations in the country appears to be an outcome of strategic considerations embodied in its five-year plan which include a greater focus on core markets in Eastern Europe, notably Poland. Already in 2011, the group announced that it would be willing to sell Kazakh JSC ATFBank at an appropriate price, and completed the deal with a Kazakh investor, KazNitrogenGaz LLP, in March 2013. UniCredit’s Bank Austria, bought ATF (the fifth-largest Kazakh lender) for USD 2.1 billion in 2007. Similarly, the withdrawal of RBS appears to have to have been outlined in its strategic orientations at the MNE headquarter level.

Number of banks in Kazakhstan according to ownership status, 2014-15

Source: National Bank of Kazakhstan.

In order to ensure that these and other divestments are not caused by weaknesses of business climate and to help retain investments, the government should consider engaging in dialogue with investors that either already divested or announced future divestments on the underlying causes.

Source: UniCredit, Bloomberg, Reuters, National Bank of Kazakhstan, Dealogic.

The trend in declining FDI flows in recent years has been reflected both the declining shares of cross-border mergers and acquisitions (M&A) activity in Kazakhstan, whereby domestic M&A deals have played an increasingly more important role, as well as reduced greenfield FDI performance (Figures 1.6- 1.7). Still, inward FDI flows continue to play a larger role in the Kazakh economy than they do in other CIS countries (Figure 1.A1.3 in Annex 1.A1) and, thus far, remain positive, which means that net divestment is not observed. The value of investments by foreign firms via M&A also outweighs the value of foreign M&A divestures (Figure 1.A1.4 in Annex 1.A1). According to the Kazakhstan’s national statistical office, as of today, foreign enterprises operating in the country account for 61% of industrial output, 66.2% of total exports, and 5.4% of total employment.

Figure 1.6. Cross-border and domestic M&A activity in Kazakhstan, 1995-2015

Note: Deals are identified as cross border when the target and the acquirer are of different nationality.

Source: OECD calculations using Dealogic M&A data.

 https://doi.org/10.1787/888933452699

Figure 1.7. Greenfield FDI Performance Index, 2003-14

Note: The Index is calculated as a share of country’s GDP in the world’s GDP divided by the country’s share in the world’s announced greenfield FDI (normalised around 0). A value > 0 means that a country attracts more FDI than predicted by the size of its GDP.

Source: OECD calculations based on World Bank’s World Development Indicators and UNCTAD’s World Investment Report.

 https://doi.org/10.1787/888933452709

FDI by sector

With its large oil and mineral deposits (IEA, 2015), Kazakhstan has historically attracted significant amounts of FDI into its oil and gas sector. Already in the early stages of its independence in 1990s, the sector attracted foreign entrants, including Chevron, Lukoil, Texaco and Canadian Hurricane Hydrocarbons Ltd (Peck, 2002). Today, geological exploration and prospecting activities account for 53% of inward FDI stock, i.e. 72 billion USD (Figure 1.8), followed by mining and quarrying (19%). Most of global market players in the sector are present in Kazakhstan, including Chevron, BP, Exxon, Royal Dutch Shell, and Total, and foreign-owned firms, including joint ventures, dominate the sector.2 The high concentration of FDI in extractives sector also influences the country’s trade structure, whereby the country exports primarily fuel to the EU (about 40 billion USD annually) and imports machinery and equipment from the EU (for the use in extractives) as well as refined oil from CIS countries (Figures 1.A1.6 and 1.A1.7 in Annex 1.A1). Kazakhstan still records some FDI in its manufacturing sector (10%), the majority of which is directed at the basic and fabricated metal products sector (84%), followed by food products and tobacco (7%). Most recently, the FDI inflows into the oil and the associated architectural, engineering and technical services sectors have shrunk, reflecting the economic difficulties related to lower oil prices (Figure 1.9). The cross-border M&A activity in the oil and gas sectoralso declined (from 74% in 1996-2001 to 50% in 2008-15), but jointly with mining still accounts for over two thirds of total M&A deal value in the country (Figure 1.A1.5 in the Annex to this chapter).

Figure 1.8. Inward FDI stock in Kazakhstan, 2015

Note: Data as of as of 30/06/2015.

Source: National Bank of Kazakhstan.

 https://doi.org/10.1787/888933452714

Figure 1.9. FDI inflows in Kazakhstan by sector, 2003-12

Source: UNCTAD, National Bank of Kazakhstan.

 https://doi.org/10.1787/888933452726

FDI by country of origin

According to Kazakhstan’s FDI statistics, the EU is by far the most important foreign investor in Kazakhstan, followed by the United States, Japan, the People’s Republic of China (China), and Russia (Table 1.1). It is worth noting, however, that the Netherlands, a country with significant share of resident special purpose entities (SPEs), accounts for a lion’s share of both Kazakhstan’s inward and outward FDI. This phenomenon reflects the growing difficulty of capturing accurately the true origin of investment, which is channelled increasingly through holding companies and other corporate structures used for purposes of tax or other reasons (OEDC, 2015). An increasing number of countries, including Netherlands, report their FDI statistics with a breakdown of investment undertaken by resident SPEs and non-SPEs (see Box 1.2 for more detail). The OECD home-country FDI statistics confirm that nearly 80% of inward FDI from the Netherlands in Kazakhstan comes from resident SPEs (Table 1.A1.1 in the Annex). Most of Kazakhstan’s outward FDI is located in resident SPEs as well, as discussed next. This highlights the importance of improving the methodology for compiling domestic FDI statistics to discern better the true origin and destination of investment as well as suggests that some of the inward FDI in Kazakhstan may in fact be domestic investment channelled through holding companies located abroad, and vice-versa, complicating the understanding of the underlying investment trends.

Box 1.2. Special purpose entities: why do they matter for FDI statistics?

Special purpose entities (SPEs) also called shell or shelf companies are companies that do not have substantial economic activity in the country but are used by companies as devices to raise capital or to hold assets and liabilities. With the proliferation of international activities and increase in intra-frim trade, including in intangibles, it has become increasingly easy for companies to shift profits across jurisdictions according to the most favourable tax environment through corporate structures built for that purpose. Just as gross trade flows may obscure the destination and origin of value-added produced in a given economy due to multiple shipments of goods across borders during the production process that spans several countries, so the passing of funds through SPEs can lead to the inflation of FDI statistics and the obscuring of the ultimate source and destination of FDI.

The OECD Revised Benchmark Definition of Foreign Direct Investment (BMD4) recommends that countries compile their FDI statistics excluding resident SPEs, and, then, separately for resident SPEs to provide a more meaningful measure of direct investment into and out of an economy. For the country hosting the SPEs, this recommendation improves the measurement of FDI by excluding inward FDI that has little or no real impact on their economies and by excluding outward FDI that did not originate from their economies. Four countries – Austria, Hungary, Luxembourg, and the Netherlands – have reported FDI flows and positions excluding resident SPEs to the OECD for several years. With the implementation of the latest standards, 9 additional countries – including Chile and eight other countries3 – have now reported data excluding resident SPEs. Inward investment positions are the value of the accumulated stock of foreign investment in a host country. Figure 1.1 shows the percentage of inward positions accounted for by resident SPEs in 2013. The countries are displayed according to share of investment accounted for by resident SPEs.

Inward FDI positions by resident SPEs and non-SPEs in selected OECD countries, 2013

Source: OECD International Direct Investment statistics and IMF.

Even in countries where SPEs do not play a significant role in FDI currently, it is useful to be able to identify resident SPEs in the statistics so that their role in FDI can be monitored. By their nature, SPEs can be formed easily and can grow rapidly. In addition, SPEs can have large transactions in a particular period that can distort FDI flows due to their role within the MNE of providing financing or holding assets and liabilities. By compiling FDI statistics that exclude resident SPEs, FDI statistics are not overstated by including funds that are simply being channelled through the SPEs, are easier to interpret for policy-making and other purposes, and provide a better measure of FDI that is likely to have an economic impact in the host economy.

Source: OECD. For more information, see the OECD website on International Investment Statistics: www.oecd. org/daf/inv/investment-policy/oecdimplementsnewinternationalstandardsforcompilingfdistatistics.htm

Other sources of information provide additional insights on the activity of foreign firms in Kazakhstan. For example, information on the operations of foreign affiliates of multinational firms4 suggest that the largest number of foreign affiliates operating in Kazakhstan stem from the United States (22%), followed by Germany (16%) and the United Kingdom (12%). These companies include many of the Global Fortune 500 and other large TNCs.5 According to merger and acquisitions (M&A) data, in turn, foreign investors from the Russian Federation, the United Kingdom and the United States have engaged in the largest number of cross-border M&A deals in Kazakhstan in the past fifteen years; while investors from China, the Russian Federation and the United Kingdom have been most important in terms of the total registered deal value (Figure 1.10).

Figure 1.10. Top five cross-border M&A investors in Kazakhstan by nationality of the acquirer, 1995-2015

Note: Acquirer nationality is defined to mean the country where the acquirer is either headquartered or has the majority of its managerial operations in.

Source: OECD calculations using Dealogic M&A data.

 https://doi.org/10.1787/888933452739

Outward investment

As mentioned earlier, the investments of foreign companies in Kazakhstan outweigh the investments of Kazakh companies abroad. Outward FDI stock (of USD 26.1 billion in 2015) accounts for 12% of GDP, and outward FDI flows (of USD 2 billion in 2015) for 2% of GDP. Also, most of Kazakh outward FDI is directed into head offices and management consulting services (Figure 1.11), which suggests that some of that investment may be investment round-tripping for tax or other purposes. Kazakhstan’s outward FDI stock may hence be even lower than suggested by the official statistics. Nevertheless, there are examples of several active investment projects by Kazakh enterprises abroad, including investments by state oil company KazMunayGas in the Rompetrol Group refinery in Romania worth USD 3.8 billion6 and smaller investments by trade companies, banks, and other financial institutions in the Russian Federation, Turkey, the Kyrgyz Republic, and other countries (Eurasian Development Bank, 2013; Asian Development Bank Institute, 2014).

Figure 1.11. Outward FDI stock in Kazakhstan, 2015

Note: Data as of 30/06/2015.

Source: National Bank of Kazakhstan.

 https://doi.org/10.1787/888933460099

FDI has played an important role in Kazakhstan’s modern history, accounting for about 50% of the country’s GDP throughout the 2000s. Some Kazakh companies, in particular state-owned enterprises (SOEs), are also active abroad. Most recently, Kazakhstan has encountered some difficulties in attracting FDI, primarily due to lower global commodity prices as well as consequences of the global financial crisis. In some sectors, in particular in banking, there have been departures of several large global players. Still, on average, foreign firms invest more than they divest in Kazakhstan (i.e. the net investment-divestment ratio remains positive), and, according to business surveys, the country remains an attractive place to invest in the region (EY, 2016). While reasons behind firms’ investment and divestment decisions are often diverse and may lie outside of the scope of policy action, the strength of the local business climate and proactive investment attraction policy can be important factors. The following chapters discuss different aspects of investment climate in Kazakhstan and consider how the country could improve its policy framework for investment to retain and attract FDI, including in non-traditional sectors.