2. 2
Table of content
1. Financial system
2. Monetary system
3. Exchange rate system
4. Financial markets
5. SWOT Analysis
6. Risk Analysis:
a. Political
b. Exchange Rate
c. Sovereign
7. China Petroleum and Chemical Corporation (Sinopec Limited)
a. Identification of exposure to the exchange rate risk
b. Recommendations
3. 3
1. Financial System
The Banking system of the Republic of Kazakhstan is a two-tier banking system. The National
Bank of the Republic of Kazakhstan (“the National Bank” hereinafter) is the central bank of
Kazakhstan and is the upper tier of the banking system of Kazakhstan. It is responsible for
ensuring price stability in the country by maintaining inflation at low levels. All other banks
are the lower tier of the banking system with the exception of the Kazakhstan Development
Bank (KDB), which has a special legal status.
2. Exchange Rate System
In August 2015, the government introduced the free floating exchange rate system for the
Kazakhstani tenge (domestic currency). At the beginning the floating exchange rate caused
an initial sharp depreciation of the currency and an increase in inflation; as well as, eroded
real wages and consumer purchasing power. As this report is being written one tenge is worth
$0.0030USD. They adopted this floating regime as a response to the fall in oil prices and to
increase competition in Eurasian markets.
3. Monetary System
After the floating system came into place the National Bank changed its monetary policy to
an inflation targeting system.
Consumer prices rose by 11.5% in October 2015. It is the lowest inflation rate since last year.
(See Graph 1)
(Graph 1, November 2015-Present, Kazakhstan inflation rate, Source: World Bank)
Very recently, the national bank of Kazakhstan started gradually decreasing the interest rate
from 17% to 12% in order to stimulate the economy. (See Graph 2)
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(Graph 2, November 2015 – Present, Kazakhstan interest rate, Source: World Bank)
4. Financial Markets
The Kazakhstan stock exchange (KASE) was founded in 1993 in Almaty (the capital). KASE
operates on the following markets: foreign currency market, government securities, equity
securities, corporate debt securities, repo transactions market and derivatives market. The
transactions are conducted in US dollars, euros, Chinese yuan and the Russian Ruble and the
tenge. The most active market participants are the second tier banks and the National Bank.
The KASE index components are weighted by the market capitalization of the most liquid
shares traded on KASE and calculated real time as trades are being executed.
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5. SWOT Analysis
Strengths
1. Kazakhstan is estimated to have 30 billion barrels of crude oil (12th
in the world), 3.7
trillion cubic metres of gas (11th
in the world), 34.5 billion tons of coal (in the top ten
countries) and 1.5 million tons (or nearly 15% of the world). With the OBOR initiative,
Kazakhstan is going to be able to export this resources to other countries with no trade
barriers.
2. They have very good relations with neighboring countries and are neutral in regional
political affairs. Kazakhstan participates in free trade agreements with the major economic
powers (China, Russia, EU and US). For example, they have a bilateral trade agreement
between the EU. They also participate in the Eurasian Customs Union which grants them
easy access to trade freely with Russia and other neighboring countries. By participating
in the OBOR initiative, Kazakhstan will further increase the number of free trade
agreements it currently has and will be able to engage in trade more freely with other
participation nations.
Weaknesses
1. The country has a high dependence on natural resources extraction. This is a cause why
Kazakhstan has not yet fully developed other industries in which it can compete with other
OBOR countries.
Strengths:
1. Abundance of natural resources such as
fossil fuels reserves, uranium, copper and
zinc.
2. Participation in major trade agreements
with Russia, China, EU and US.
Weaknesses:
1. The economy is highly dependent on
mineral resources extraction. Economic
prosperity is tied to commodities prices.
2. Largest landlocked country. No direct
access to an ocean port.
Opportunities:
1. Develop the country’s infrastructure.
2. Develop logistics industry with the
creation of a logistics hub close to the
Russian and Chinese border.
3. OBOR will lead to the acceleration
Chinese mining investment in Kazakhstan.
4. Reestablish grain production as a national
priority and export surplus to China.
Threats:
1. Unsustainable management of its water
resources.
2. The hydrocarbon economy era is coming
to its end. Newer and greener energy
sources are becoming widely adopted.
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2. Kazakhstan is the largest landlocked country in the world, which means it has no access
to ocean ports.
Opportunities
1. As a result of OBOR, Kazakhstan has already secured 33 cooperation agreements with
China to develop the country’s infrastructure. These projects are worth USD23 billion.
2. The country has great opportunities in the logistics industry. They already started the
construction of a logistics hub close to the borders with Russia and China. This will be a
critical success factor when OBOR is implemented.
3. Kazakhstan has the opportunity to increase their agriculture production (specially grain)
and export the surplus produced to other countries. This initiative is part of its strategy
plan (Kazakhstan 2050). Certainly, it will be more relevant with OBOR because they will
be able to export food to other countries.
4. Kazakhstan is going to be benefited with an influx of Chinese investment in the mining
sector. Currently, both countries have a joint-venture in the production of nuclear energy
with uranium. With these funds, Kazakhstan will be able to construct nuclear power plants
and fulfill the Chinese demand for nuclear energy.
Threats
1. The country’s environmental policy has not been very effective up to this moment.
Kazakhstan has contaminated the Caspian Sea by pouring thousands of tons of oil
pollutants. After OBOR, the country will experience economic development but it should
also consider a more sustainable management of its water resources.
2. Hydrocarbons are less used every day and the World is demanding greener energy to
protect the planet. In January of this year global leaders met in Paris and created the Paris
Climate Agreement which 192 have already signed, including Kazakhstan.
6. Risk Analysis
a) Political risk
Since 1991, Kazakhstan has been ruled by an authoritarian governance where the power is
heavily concentrated in the ‘Nur Otan’ party led by President Nursulatan Nazarbayev. The
political stability may be adversely affected by the discontent of social causes for instance
corruption, rising prices, low wages, mass protests, religious extremists and fears of terrorist
attack.
A notable protest held in May 2016 of the opposition on a land reform project that encouraged
foreigners the upper hand to on leasing of lands. However, due to the tightened security
measures of after the outbreak, it is now unlikely for mass protests to happen. Moreover, there
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is a significant uncertainty of the presidential power in respect to the transition of
Mr.Nazarbayev’s successor after his withdrawal from the office with consideration of the his
advanced age.
The government will still put social discontent as a priority to if not eliminate then reduce the
damage it may cause in the long-term through providing more social expenditure. So, social
discontent is not a major concern that may affect political instability in the near future.
Nevertheless, Standard and Poor’s outlook in the near future is that Kazakhstan will remain
stable politically.
b) Exchange rate risk
Transitioning from the lower-middle-class-income to the upper-middle-class-income status
and with the proven record of having the ninth largest oil reserve around the world,
Kazakhstan’s economy majorly depends on commodity exports followed by manufacturing
and business services.
As mentioned, in 2015 the state bank of Kazakhstan has shifted to use the floating exchange
rate meaning that the currency floats freely in the market so the risk of the Tenge is likely to
fluctuate in terms of the rise or fall of oil prices that determines the income level. In reference
to graph 2 of the country, the interest
rate of the country is relatively high as
of the present date but however it is
offset by a high inflation rate in respect
to graph 1. The major determinant of the
currency is the oil price (income level)
but due to the unpredictable fluctuation,
therefore the exchange rate risk is as
volatile as the oil prices.
(Graph 4, 2010 – 2015, Tenge’s
currency, Source: Bloomberg)
c) Sovereign Risk
According to the latest research update of the Standard and Poor (S&P)’s credit rating
sovereign report, the long and short term credit ratings are scored at BBB- and A-3
respectively with an outlook that remains negative. A sovereign credit rating is a financial
indicator that indicates the level of risk to a potential investor and apparently, India is in the
lower medium-investment grade.
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Kazakhstan being rated at BBB- in the long term credit rating is an implication of the S&P’s
long-term issuer credit ratings’ definition “An obligor rated 'BBB' has adequate capacity to
meet its financial commitments. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the obligor to meet its
financial commitments” (S&P credit rating definition, 2016). The rating outlook assesses the
which direction Kazakhstan may take over six months to two years’ time and is assessed at
‘negative’ signaling that it is likely to change its outlook with considerations for possible
changes of any economic and or fundamental business conditions within the country.
According to the research update on solvency report of Kazakhstan, the economic conditions
and changing circumstances such states that the centralized political environment that is too
concentrated in one political party (Nr), high dependency on commodity exports and low oil
price, inflexibility of the monetary policy and slow level of economic development hinders
the positive outlook. Moreover, the feeble global commodity environment also adds on as a
factor along with the decline of the fiscal performance supported by the fall of oil price over
the two years. Even so, the government has kept the debt level as low as 20% of the GDP
remaining in a net creditor position. (S&P, 2016)
(Graph 5, 2004– 2015, Kazakhstan Debt to GDP, Source: Bloomberg)
From the deficit of 8.6% in GDP last year, it is expected to increase is as close to zero this
year moving in an upward direction from last year, which will reach positive figures by 2017.
An average annual surplus of 3.5% of GDP is speculated over the next five years. The
contributing factors are:
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(i) On one hand, the oil price is expected to increase over the years and on the other,
‘the Kashagan oil field is expected start its operations in the Caspian Sea that will
contribute to the state bank’s revenue.
(ii) The government’s spending and expenditure was a major factor that lead to a
deficit, it is strongly believed that with containing the government’s spending
according to priority would reduce the deficit figures.
(iii) The performance of government revenue is also expected due to the authorities’
plans on revamping the tax administration and collection process that will optimize
the tax legislation thus generating supplementary income.
Over the medium term, the GDP in
early 2016 will experience deficit by
4% of GDP but the start of Kashagan’s
oil field and increase in oil prices will
offset the current account’s depletion
of import as a result of decline in
private consumption and country’s
Tenge and in addition to the
ineffective sovereign institutions, the
outlook of Kazakhstan will remain
negative.
(Graph 6, 2012– 2016, EIU Sovereign Risk Score for Kazakhstan, Source: Bloomberg)
7. China Petroleum & Chemical Corporation (Sinopec Limited)
Sinopec Limited is a Chinese oil and gas company based in Beijing, China. It is currently
listed in Hong Kong, Shanghai and New York. Its parent company, Sinopec Group is the
largest oil refining and petrochemical company in Asia. Sinopec Limited operates in every of
the oil and gas segments, every of the petrochemicals segments and the import/export of
commodities.
The reason we picked Sinopec Limited (“Sinopec” hereinafter) is because last year they
acquired 50% ownership of Caspian Investment Resources (CIR), a Kazakhstani oil and gas
company. Sinopec will now have an exposure to the exchange rate risk of Kazakhstan and the
success of this acquisition might be determined on how well they deal with this risk. In the
text below the transaction, economic and translation risks are going to be identified and some
recommendations are going to be made on how to manage the potential exchange rate risk.
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Transaction exposure risks
Sinopec acquired an interest in Caspian Investments Resources (“CIR”) in order to help
satisfy China’s energy demand. In other words, Sinopec could at some point have financial
obligation abroad, by importing crude oil from its subsidiary and paying in foreign currency
(tenge). This will expose the company to a transaction risk. For example, Sinopec makes a
contract with CIR in which they will buy crude oil the next year and pay a fixed amount in
tenge. If the tenge appreciates then Sinopec will be negatively affected because importing
crude oil from its subsidiary will become relatively expensive. They will require more RMB
to buy the same quantity of crude oil agreed upon.
Our recommendation is to use a hedging strategy to lock in an exchange rate and eliminate
the transaction exposure risk.
• Buy and hold the foreign currency – the company could buy the tenge needed to pay for
the crude oil at the date the contract is established. They should hold on-to the tenge until
the contract settlement date.
• Forward contract – the company uses a forward contract to lock in a price for the foreign
currency at the date the contract is established. They would have to pay the agreed price
for the tenge. This strategy is effective if for hedging an appreciation of the tenge, but if
instead the foreign currency depreciates then Sinopec will not benefit from it.
Economic exposure:
Although the depreciation of the Renminbi has made a significant profit for the Sinopec
translated currency exchange but it is inevitable for the company to economic exposure risk.
The unanticipated changes in the exchange rates may affect the operations of the company,
the Renminbi is relatively stable in comparison to the Tenge that fluctuates according to the
volatility of the oil prices. For instance, the Sinopec company may import oil from the Caspian
Investment Resources and if the Tenge’s currency appreciates against the Renminbi then it
would increase the cash outflow of the company thus making it more expensive to purchase
oil from Kazakhstan and hurting it’s operating income vice versa noting that the Company is
made committed to purchase from its joint venture and subsidiaries based on market prices,
no exception. The company can consider to hedge its business writing up currency risk-
sharing agreements where they reach a consensus to share the risk of the unpredictable
exchange rate fluctuation. Another method is implementing back-to-back loans in other words,
credit swap so the company and CIR can borrow each other’s currencies for a period of time.
After the repayment, each company will be able to receive collateral in a foreign currency
which appears on both of their balance sheet as an asset and liability.
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Translation exposure:
Sinopec Limited consolidated financial statements of all its subsidiaries outside China are
translated from their home currency to Renminbi at spot exchange rates as quoted by the
People’s Bank of China (PBOC rates) on the day of transaction.
In reference to the statement above, the company faced a loss in the translation difference in
its foreign currency statements during the year 2014 because of the high exchange rate of the
currency. However, over last year, Renminbi devaluated its currency and remained rather low
against other currencies so the depreciation increased the translation earning of the Company.
Therefore, Sinopec faces the risk of translation exposure while doing business in Kazakhstan
due to the volatility of the Tenge’s exchange rate that is determined by the volatility of the oil
prices. Sinopec can consider to buy the Tenge forward before receiving the accounts
receivables from the CIR which could possibly maximize the translation differences.
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References
HHoward, KWF, and KK Howard. 2016. The new "silk road economic belt" as a threat to the
sustainable management of central Asia’s transboundary water resources. Environmental
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FERDINAND, P. (2016), Westward ho—the China dream and ‘one belt, one road’: Chinese
foreign policy under Xi Jinping. International Affairs, 92: 941–957. doi:10.1111/1468-
2346.12660
Economics, F. (2015). Retrieved November 24, 2016, from
https://www.focuseconomics.com/country-indicator/kazakhstan/exchange-rate
International Monetary Fund, I. (2015). IMF. Retrieved 2016, from
https://www.imf.org/external/pubs/ft/scr/2014/cr14243.pdf
S&P. (2016). Ratings Direct, Kazakhstan. Research Update.
World Bank, Kazakhstan . (n.d.). Retrieved from
http://data.worldbank.org/country/kazakhstan
