ADB Director General of Central and West Asia Department Werner LIEPACH:
KAZAKHSTAN NEEDS TO REVISE TARIFF SETTING MECHANISM TO ATTRACT MORE GREEN INVESTMENTS

The Asian Development Bank (ADB) adopted last year the new Partnership Strategy for Kazakhstan for 2017-2021. In accordance with the Strategy, the ADB will focus on the financing of clean energy projects. Director General of the ADB Central and West Asia Department Werner LIEPACH, told Interfax-Kazakhstan in an interview on the sidelines of the 11th Astana Economic Forum about new opportunities that the ADB sees in Kazakhstan.

- ADB in the April forecast slightly adjusted Kazakhstan's GDP forecast - from 3.3% to 3.2%. What is the reason for this? What challenges, in your opinion, are the most relevant for Kazakhstan at the moment, and what measures are needed to confront them?

- Slightly revised GDP growth projection is based on slower than earlier expected growth forecast for the services sector. But general environment is actually quite positive and going forward we certainly see an upward projection of GDP growth. I think that external environment is a bit more positive in the sense that the oil prices have come up, which generally helps Kazakhstani economy.

By large I think the challenge for the Kazakhstani economy is to improve its competitiveness. That's one of the challenges. I think if you look at the energy sector, it's still very inefficient. I think there are a lot of opportunities for improving efficiency in the economy in general, which Kazakhstan is trying to achieve. When you go down to the sectorial level, you will find that in virtually all subsectors. I was just at the conference on green financing. The marginal cost of energy production is relatively low because there are a lot of old Soviet-time power plants. The efficiency of these plants is not very high, and they are also very polluting. So, we may have energy, but it is a very polluting energy. Increasingly it becomes very costly to maintain these power plants. At one stage these power plants will just die, so the country needs to invest now into new, modern, green plants. If you look at the energy distribution system, there are a lot of high distribution losses, so the country needs to introduce a lot of things like smart metering in order to reduce these losses. Transmission lines are the same - you can reduce the losses there. That in turn could also reduce the need for additional energy consumption. This is just an example in the energy sector.

Livestock is one area where there is a lot of potential for Kazakhstan. Again, many of these things are still based on legacy systems, so one really would need to optimize and analyze the value chain and see the ways that the country can improve the efficiency. If you go into various industries, you can find a lot of potential. Heating is another area. Heating systems are outdated, and a lot of energy is wasted. Also, one needs to look at the pricing structure. As long as energy prices are very low, people are actually consuming a lot. So, I think there is a lot of scope for doing some adjustments for improving efficiency.

- As ADB Country Director for Kazakhstan Giovanni Capannelli previously told us, according to the new partnership strategy for Kazakhstan (for 2017-2021), ADB was going to move from sovereign financing in the country to a mixed one. How is this process going?

- Since last year we have approved two more projects. One was non-sovereign project in the energy sector for Samruk Energo, and that was the first time we approved a loan for a public-sector enterprise without a sovereign guarantee. Then earlier this year we approved an investment in the private sector - Baikonur solar energy project - that is a $12 million investment. These are all new initiatives. When Giovanni talked about blended finance what he meant was blending of sovereign and non-sovereign finance. That is something we would like to develop further. We are here in discussions with the government to develop a pipeline for the next three years. Over the next four to six weeks we'll try to firm this up, and we'll look at the pipeline from 2019 to 2021 projects. We hope to develop a pipeline of about $2 billion for this period.

- What's the priority for this period?

- The priority depends very much on what the government wants us to do. We are very much client-oriented. We have a country partnership strategy, and we do have corporate priorities in the bank. Corporate priority at the moment is clean energy.

Also, we a have a regional integration program ongoing. It's called CAREC – Central Asia Regional Economic Cooperation program, and Kazakhstan is its important member. I think there is a general awareness in the region of the importance of regional integration. You know the Belt and Road initiative, of course. Also, Uzbekistan is more active now, opening up to the neighboring countries including, of course, Kazakhstan. So, we see that there are huge opportunities to support the regional cooperation, and we will continue to support investment in the transport infrastructure to establish the linkages. Energy infrastructure is also very important. As I said, there are a lot of inefficiencies in the system. Perhaps, we can also help in this area.

Then we see potential in new areas. We have been involved in agribusiness and we are currently looking into livestock development. Then we have a concept of what we call economic corridors. Currently we are working on Almaty-Bishkek economic corridor where we try to have regional connectivity projects in the border regions. It's a win-win because you might have producers in Kazakhstan, in Almaty, and then in Bishkek on the Kyrgyz side, and rather than producing only for the home market, by combining we can have a larger market. Then on Uzbekistan-Kazakhstan side there is Tashkent-Shymkent corridor.

These are some of the new initiatives we're looking at – agribusiness and economic corridors. Also, I think that strengthening the banking system and sound financial system are a very important prerogative for supporting growth.

- What do you mean by strengthening the banking system? Would ADB provide technical assistance?

- We have had a discussion with the National Bank of Kazakhstan on possible assistance with the banking supervision that could ensure the soundness of banking system. We have also been in discussions with the Ministry of Finance for some assistance, possibly in debt management. These are all financial sector activities. We would start with the technical assistance, and then based on the findings of the technical assistance we will assess whether there is a need for further lending assistance from ADB.

- Last year a new CAREC strategy was approved. What are the priorities of the program in the medium term?

- The CAREС program was established in 2001. It has now been in operation for 18 years. The total amount of investment in this program over this period is $31,5 billion. Last year we approved a new strategy for CAREC, called CAREC 2030. There are a few important changes in this strategy. First, the past strategy was focused very much on projects in energy, transport and trade facilitation. But the new strategy takes a wider view of the sectors we are looking at. So now we will also include sectors like agriculture, agribusiness, even tourism, agriculture, and a lot of other areas.

Secondly, we will not just provide projects, but also a platform for a policy dialogue, which means the exchange of knowledge and experiences. We’ve just had our first knowledge event here in Kazakhstan, because of the Astana economic forum a lot of important people are here, so we were leveraging on this. We had one specialized event that was looking at improved regional integration. Ministers from eight countries participated and exchanged frank views on what could be done to improve the regional cooperation.

We will see more of these high-level policy events for CAREC, because we realize that projects alone will not have impact unless we also have changes at the policy level. I think right now CAREC is really becoming more important. There is a Belt and Road initiative driven by China, that is one initiative, and CAREC is actually a counterweight, which provides a balance for the Belt and Road initiative. CAREC is a multilateral initiative and is driven by its members. China is a member, too. Uzbekistan is opening up. It is a very important member of the CAREC family, which I think could help provide efficient linkages. If you're looking down southwards to Pakistan and at getting access to the ports, it's quite important to have this regional cooperation working.

- Could you tell me more about Tashkent-Shymkent economic corridor? I haven't heard about that initiative.

- That is because Almaty-Bishkek is the first corridor, and we already approved technical assistance for this program, which is under implementation. Tashkent-Shymkent is a very recent development that came up after Uzbekistan changed its attitude towards regional cooperation. We have not yet started fully our work on this, but we had informal discussions with both Kazakh and Uzbek governments saying that we would like to develop this corridor. It's of a larger scale because we would have a combined larger population in that corridor than in Almaty-Bishkek. Tashkent-Shymkent is not yet formalized, but we're exploring this initiative. But Almaty-Bishkek is important because it's the first one and it could be a model for other corridors. The lessons learnt could be then applied to the new corridors.

- Could you remind me what do economic corridors entail, apart from the roads?

- It's a couple of things. Apart from being a road, it is also ensuring that custom procedures and clearances are very smooth, so there is a soft component in there, plus there will be other infrastructure in Almaty-Bishkek area. I think there is a lot of potential for agroprocessing, so what we need is, for instance, food warehouses. I'll give you an example. Let's assume both countries produce a certain fruit or flower, and they need to have a cold storage. It may be more efficient to have just one cold storage or one big wholesale market that covers the whole area than having everything in each market because it would be duplicating it.

For instance, you put a wholesale market for a certain product in Kazakhstan so that the producers from Bishkek could also access it, and then sell their products also in Kazakhstan, and vice versa. It would give bigger markets to the producers of those countries. What you then need to do in the economic corridors is provide infrastructure – market infrastructure, and bring in the soft infrastructure, like custom procedures. And the outcome of the economic corridor is that you see economic activity. As I said, the road is very important, because at the end of the day you need to access the markets, to have an economic corridor, where to the left and to the right you have warehouses, shops, et cetera. It will help generate growth and employment. This is the concept.

- So it all comes down to infrastructure…

Yes, but not all infrastructure needs to be delivered by the government. The infrastructure can also be provided by private sector. What the government needs to do is provide the economic framework for private sector to invest. These are the issues like making customs clearance easier, and so forth. This is where the concept of public-private partnership is very important. It's not just for the government to build infrastructure, and then people may or may not use it. The private sector is generally more diligent in doing the economic analysis, they will only invest if they can see a possible return on this.

- In your opinion, how will Iran's accession to the FTA with the Eurasian union affect trade in the region?

- Iran of course is a very special case. It's a very important country geographically because it really breaches Asia towards Europe on the southern part of it, so the link to Turkey goes through Iran. Every effort that brings Iran into the regional community is welcome. Of course, what is a limiting factor now is the decision by the US, which means sanctions will be imposed on countries and companies that would be trading with Iran. So, what you see is one positive development, and one negative development. I wish it was also all positive, because I'm a strong believer in integration and doing things together. And I do think that Iran has a very important role to play. Iran is not a member of the Asian Development Bank. Therefore, we did not have any direct operations in Iran, but we do have operations in the Caucasus region. Georgia and Azerbaijan are also members of the CAREC. Then we have Afghanistan, Turkmenistan and Pakistan. They are also members of the CAREC. All these countries border Iran, so from a regional connectivity perspective it would be quite good to have Iran joining the regional integration process.

- You mentioned green financing. I have read that the potential of green bonds in Asia is huge, but not all countries use it or even know what it is. Do you think Kazakhstan could use this potential as well?

- Green bonds or green financing generally is financing for infrastructure projects that are environmentally sustainable. In Kazakhstan there is a lot of sun, solar intensity is very high. You also have a lot of potential for wind power. Then there is a potential for hydropower – in particular, in the eastern region where the mountains are. And we haven't even talked about geothermal potential. I think that has not been fully explored. It appears there is a huge potential for green infrastructure projects, green energy projects in Kazakhstan.

One of the challenges is that of course the cost of the green projects is still a little bit higher than that of the traditional projects, though It has come down a lot. Solar has become very competitive now. But if you would like to make a solar project, the tariff is likely to be higher compared to the tariff for energy produced by existing coal plants. If you want to realize the investment, I think you should also do some policy adjustments in the energy sector, in particular as far as the tariffs are concerned. Because otherwise, unless the projects are also economically viable, they may not happen. Technical viability is there, and there are a lot of opportunities. There is water, there is wind, there is sun. But economics also needs to be looked at.

I think one would need to look at the whole regulation in the energy sector and the tariff setting mechanism, and perhaps some adjustments are needed there to provide proper incentives to make these green investments happen. For instance, there could be a pollution tax, that can tax energy according to the pollution it produces. Some countries do that with cars. I come from Germany, and we have to pay a tax for our ownership of a car, and the level of the tax depends on the amount of pollution of the car. Something similar could be done in the energy sector. Then of course the economic dynamic would change.

- So, they could reward owners of electric cars or cars running on natural gas…

Yes, for instance, it's now more expensive to buy an electric car, and if the fuel is too cheap, why would people buy electric cars? That's why I think tax can be a very effective instrument to direct policies. If you want to have a green Kazakhstan, I do think there is a lot of potential. Generally, existing infrastructure is a legacy of old Soviet times, when there was a relatively heavy industrialization. The replacement of those inefficient industries with efficient analogs or new technologies that are now emerging needs to be promoted.

I think that is the challenge that Kazakhstan in the broader sense faces – finding your scope between East and West, looking at what industries and trends are emerging, and what could be Kazakhstan's comparative advantage. I do think there are a lot of advantages. The country is rich in natural resources, but it also has a big land area. If we look at the population growth in the world, people need to eat. And as people become wealthier, they want to have more quality food. So, Kazakhstan could be a producer of quality, organic food. People are prepared to pay a premium, so rather than just providing food, provide quality food. Make processing meaningful. Where I come from, everybody talks about Argentinian beef. Why don't people talk about the Kazakh beef? That's an opportunity. Cattle breeding needs a lot of land, and it also has a negative impact on climate change. But then you could also use the biomass of the cattle to produce energy.

I am quite optimistic about Kazakhstan, because it's quite well endowed, and it doesn't face a population pressure that some other countries have.

- What do you mean?

- If you look at the big megacities in South-East Asia, for example, the access to water there becomes increasingly a problem. I was working in Pakistan for many years. The issue there is that the cities have grown out of control, and the service provision is not keeping up. The infrastructure is so dilapidated, there are too many people there, the urban infrastructure is collapsing. Water is a big issue. Again, Kazakhstan is in a better situation in this regard, but in a lot of countries there is a limited water supply and the population is growing too fast, which creates big challenges.

Generally, I think the leadership is forward looking, it's progressive, maybe sometimes a little bit cautious of implementing the reforms. We talked about energy - how you would manage the reforms, if energy becomes more expensive, even if it is cleaner…

- It's still more expensive.

- Yes, and some people may not appreciate it. This is also a challenge: how do you manage domestic issues? I think it makes perfect sense to have clean energy, because in the long run it has a lot of other benefits. And of course, it does not mean that people have to pay more for energy, because they can conserve it. Take heating, for instance. I mean if you have housing that is very inefficient, and you lose a lot of energy, you need to consume a lot of energy to keep your place warm. If you have a more efficient housing you don’t need as much energy. So even if the energy is more expensive, it doesn't cost you more. And the overall impact would be positive, because you would have less pollution.

These are the kind of economics, where I see a lot of scope in Kazakhstan. That's what I said in the beginning of our talk. If you go in the value chain of various industries, you may identify quite a bit of scope for improvement. It doesn't mean necessarily that it would cost more. It actually would mean that you generate benefits by being more productive, and by increasing your productivity that would translate in the GDP growth.

So, when you ask about the opportunities for Kazakhstan to grow, my answer is in improving the productivity.

- Thank you for time!

June, 2018
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