Amply endowed with natural resources but handicapped by its landlocked situation, Central Asia has experienced unparalleled growth rates over the past ten years. The exploitation of these resources and the investments that have been made, often with the help of foreign capital, provide the basis for this paradigm of growth and productivity. However, many challenges including economic diversification and private sector development hamper future growth prospects.



Abundant Resources in a Landlocked Region


The existence of oil deposits is a major factor in the distribution of wealth among the Central Asian republics. While on one hand Kazakhstan and Turkmenistan, and to a lesser extent Uzbekistan, have major reserves of fossil fuels, on the other, Tajikistan and Kyrgyzstan have no oil and gas reserves at all. This difference can be seen in national economic indicators. In 2009, Kazakhstan’s GDI per capita in purchasing power parity (PPP) was more than US$10,000, five times greater than that of Kyrgyzstan or Tajikistan. Besides oil and gas deposits in the Caspian Sea, Central Asia also has abundant natural resources. Gold deposits in Kyrgyzstan account for 15 percent of its GDP. Tajikistan has significant hydroelectric potential, and Uzbekistan is one of the world’s leading exporters of cotton, though its gold deposits could potentially make it a major gold-exporting country. Kazakhstan is richly endowed with natural resources: a major exporter of wheat and flour, the country also has large deposits of precious metals such as chromium, zinc, lead, and uranium.


What these countries have in common is their geographical location, which is both a disadvantage and a source of opportunity. Being landlocked is first a disadvantage in that many countries have low population densities. Difficult climate also tends to increase the transaction costs associated with trade such as the costs of crossing borders (time spent in customs, possible corruption, the unpredictability of delivery dates, etc.) as well as costs of transport and storage. It is secondly a source of opportunity in that Central Asia lies mid-way between Asia and Europe and could therefore serve as a transit zone and logistics platform for trade between the two continents. Overcoming the problems arising from being landlocked is key to the future success of the region.


The key limitations implied by this geographical situation is high transportation cost, waste due to lack of ‘cold’ supply chains in the agro-business sector, and most importantly, slower pace in development of sub-national regions due to high cost of infrastructure. The creation of transnational transport infrastructure and the elimination of red tape at border crossings within the region call for close cooperation among the countries in the region, which could use improvement. A key to addressing this challenge and improving the competitiveness of the region is also tapping into the potential of its neighbours. Although land-locked, Central Asia is also surrounded by some of the world’s fastest-growing and most dynamic economies, including three of the BRICs (Russia, India and China). Recognizing the importance of being further connected to their fast-growing neighbours, Central Asian policy makers have embarked on a number of initiatives. One example is the Central Asia-China gas pipeline, which was launched in 2003 and is set to become the first pipeline to bring Central Asian natural gas to China. It connects Turkmenistan, Uzbekistan, Kazakhstan, and China.


 




A Natural Resource-Driven Growth Model


Over the past ten years, the economic growth rates of Central Asian countries have reached record levels for a variety of reasons, including high prices commanded by raw materials in world markets and relative macroeconomic stability, with single- and sometimes double-digit inflation compared to the much higher levels reported in the 1990s; for the poorest states in the area (Tajikistan and Kirghizstan), remittances of earnings by emigrant workers in Russia as well as financial aid from abroad have played a major role.


Another key to the region’s success has been increased investment, and notably foreign direct investment (FDI) from the Organisation for Economic Cooperation and Development (OECD) member countries, Russia, and also China. Admittedly this investment has been directed towards natural resources, but not exclusively so. The construction, financial services, and metallurgical sectors have also seen FDI flow into Kazakhstan, while the textile industry in Turkmenistan likewise profited from FDI. Central Asia (and the Caucasian countries) could therefore be described as a region benefiting from a third wave of FDI in the post-communist zone, the first wave having been directed at Central and Eastern Europe in the early 1990s, and the second wave having been directed at South-East European countries in the early 2000s.


The exploitation of natural resources is a prerequisite for the development of the region and projects therefore tend to be large-scale; hence the use, or at least partial use, of foreign funding such as export credits (contracted by the importer) or project financing loans. The OECD assigns credit risk ratings to almost all countries in the world. The method used to classify country risk ratings measures the probability that a given country will be able to service its foreign debt. However, the countries of Central Asia still have poor credit ratings, which automatically has an impact on the cost of foreign financing due to the higher interest rates charged to cover the risks of non repayment.


And yet the exploitation of natural resources will not in itself be sufficient. First because, by international standards, the countries in this region have low to average income levels; second, because natural resources are limited; and last, because too great a dependence on raw materials increases the risks relating to variations in the economic cycle.


Diversification and Private Sector Development


Certain economic objectives must therefore be pursued: in particular the diversification of the economy and improvement of competitiveness. Agriculture employs over 40 percent of the labor force in four out of the five countries, and 30 percent in Kazakhstan. In view of the small contribution this sector makes to their GDP, this figure primarily reflects the lack of job opportunities in the secondary and tertiary sectors, and the absorption of surplus labor by the countryside. This situation might seem paradoxical in that the countries of Central Asia inherited the social education system and a reasonably well-educated labor force with literacy rates close to 100 percent. Meeting these challenges therefore calls for suitably adapted economic policies.


 



 


As part of a second or even third generation of reforms, policies for the structural reform of existing economic institutions, which often promote the Soviet brand, would be useful. These include the liberalization of certain sectors of the economy that are still heavily regulated—like the banking sector—in terms of competition or prices and even state-ownership. The share of GDP produced by the private sector is relatively low in most of the Central Asian republics, amounting to 25 percent, 45 percent, and 55 percent for Turkmenistan, Uzbekistan and Tajikistan respectively, whereas a former communist country like the Czech Republic is at 80 percent, according to the European Bank for Reconstruction and Development in 2009.


Structural reforms should be complemented by more specific strategies to increase competitiveness. This includes creating a climate conducive to private investment and initiative, especially from abroad. FDI is indeed a key element in transferring skills and technologies and helps to strengthen local production capacities. Likewise, to promote the emergence of such capacities, it would be helpful to reduce bureaucratic barriers to enterprise creation. This would include a policy promoting integration into world trade by the lowering of tariff and non-tariff barriers. Lastly, this would include heavy investment in tertiary education and skills to develop human capital.


The Case of Kazakhstan


Five times the size of France but with only 16 million inhabitants, Kazakhstan is the largest country in the region. Energy is the focus of Kazakhstan’s economy, constituting 40 percent of its GDP. Because the country receives more than 75 percent of all FDI in Central Asia, it was taken as a case study for the purposes of this article. Since 2000, Kazakhstan has enjoyed average annual growth rates of above 8 percent, thereby ranking it among the ten best performing economies in the world. To date, this good economic performance has largely been driven by the natural resources sector.


Kazakhstan alone attracts more FDI than all the other Central Asian countries combined. In 2009, foreign funding amounted to 8.2 percent of Kazakhstan’s GDP, with FDI flows accounting for over 140 percent of the total, which offset major outflows of capital in the form of bank loans. Again in 2009, 70 percent of all FDI flows to Kazakhstan were destined for oil and gas exploration and development, that is to say twice the level reported in the mid 1990s. In that same year, around 70 percent of FDI was still being provided by OECD Member countries, with major investments by the United States, the United Kingdom, Italy, France, and the Netherlands (the traditional headquarters of the major oil companies).


 



 


To improve the competitiveness of non-energy sectors and attract foreign investors, Kazakhstan must overcome two obstacles. First, OECD Member countries have invested abroad significantly less since the beginning of the economic crisis in the second half of 2008. Second, OECD countries are themselves the primary recipients of foreign investment, given that in 2009 they still accounted for almost 68 percent of all FDI flows. Kazakhstan is also competing against other high-growth emerging economies such as Russia, India or China.


Kazakhstan can count on several obvious competitive advantages to help it meet these challenges. Labor costs in the service sector are half those in countries currently attracting a new wave of investment such as Poland or Hungary, and slightly lower than labor costs in Russia.


In the agricultural sector, the countries can count on their vast prairies for cattle rearing and on vast expanses of arable land for crops. Kazakhstan, for example has almost 24.5 million hectares of arable land—the fourteenth largest area of arable land in the world. At present, up to 3.5 million hectares of arable land—i.e. around 15 percent of the total arable land in the country—are not cultivated. Opportunities exist. Let’s look at the wheat sector, for example. The excellent agro-climatic conditions are conducive to growing high quality spring wheat. Kazakhstan’s low production costs (which are half those of France for wheat, and approximately 60 percent of those of Ukraine and Russia) put this country in a good position to compete in international markets. This would particularly be the case in light of the fact that the country can profit from its geographical location, with low shipping costs to Middle Eastern countries (which are massive wheat importers) and to the European Union (two or three times lower than those of other major exporters of cereals such as Australia or the United States).


Several priority sectors for foreign direct investment could be targeted such as the agro-food sector (in particular wheat, beef and dairy products), the chemical fertilizer sector, and the logistics for the latter, as well as the IT and other business services sector (information and communication technologies, consultancies, etc.). These sectors are both attractive (which includes, for example, market growth potential) and beneficial for the country (for example, through transfers of knowledge and technologies).


Overall, Central Asia’s potential advantages of its strategic location—placement adjacent to three of the BRICs—high literacy rates and vast natural resources, coupled with growing FDI and enhanced productivity, have led to above average growth in the past 10 years. However, to raise its competitiveness sustainably, the region must make further gains in productivity, which includes overcoming the challenges that are also posed by its geographical location. Priorities to address include education, access to finance, and investment policy and promotion.