Welcome to the third edition of EY’s Kazakhstan attractiveness survey. In this new edition, we continue to analyze the latest foreign direct investment (FDI) trends in Kazakhstan and explore what investors think about the country’s investment climate, as well as its potential. This year, the country’s macroeconomic, social and political stability have taken over as the key driver of investment. This represents a shift from our previous two surveys, which showed that the country’s low labor costs and productivity gains on offer were its most appealing features. This change can be attributed in part to the ongoing instability of the global economy. It is this uncertainty that has led investors to look to countries such as Kazakhstan as a safer place to grow. The reality of foreign investment in Kazakhstan confirms this perception. While global FDI inflows declined by 18% between 2011 and 2012, Kazakhstan remained a stable destination for investors, receiving US$14b in FDI inflows. Investors continue to perceive Kazakhstan as a treasure trove of natural resources, while they also value some knowledge-based, high-value-add sectors that hold considerable promise. The Kazakhstan Government remains committed to reducing the country's dependence on extractive industries and developing a more balanced, knowledge-driven and investor-friendly economy. It continues to improve the competitiveness and productivity of priority sectors, such as agriculture and agro-processing; construction and construction materials; oil refining and support services; metallurgy; chemicals and pharmaceuticals; transportation; automotive; telecommunication; biotechnology; and alternative energy. However, our survey findings reveal a wide perception gap between foreign investors who are already established in Kazakhstan and those who are not. Current investors are much more aware of the country’s environment and are willing to explore further possibilities in the market. Conversely, Kazakhstan needs to change the widely held perceptions of potential new investors. Most seem not to have Kazakhstan on their investment radar or remain unaware of the country’s attractive features, locations and sectors that present opportunities for growth. To overcome this challenge, it is important that the Kazakhstan Government intensifies its efforts to communicate the country’s potential to the rest of the world. Even in a challenging global environment, the message can get through that Kazakhstan is building a solid framework for moving up the value chain and is developing a welcoming business culture that is conducive to innovation and growth. As we present our third Kazakhstan attractiveness survey, we would like to thank the investors who have taken the time to share their thoughts with us. We hope the report makes a positive contribution to the development of Kazakhstan’s investment climate, and provides useful insights for companies, as they prepare their future investment plans.

Kazakhstan is becoming a critical part of the emerging “New Silk Road” that connects the East with Europe, Turkey and the Middle East. An advantageous geographical position, regional integration initiatives and an improving business climate are three key reasons why Kazakhstan is emerging as an attractive investment destination. Two of the four BRIC countries, Russia and China, share a border with Kazakhstan. China and Russia are among the top three largest trade partners of Kazakhstan. Thanks to its mineral endowment, Kazakhstan has become China’s most important economic partner in Central Asia. Bilateral economic ties should expand even further, given each country’s strong growth rates and China’s growing demand for Kazakhstan’s rising exports of oil and gas. Currently, 20% of Kazakhstan’s oil is exported to China. As part of our overall industrial diversification process, we are also making efforts to cooperate further with China in non-resource areas. With the introduction of the Customs Union and Common Economic Space, the single market of Belarus, Kazakhstan and Russia contains nearly 170 million people. International trade within the Customs Union was expected to reach US$125b in 2012 compared with US$92b the year before. Russia and Kazakhstan both experienced a 37% increase in trade in the Union from 2011 to 2012. And, of course, Kazakhstan also looks forward to joining the World Trade Organization (WTO) in the near future. Kazakhstan has an increasingly business-friendly environment. The World Bank’s Doing Business 2013 index ranks it 49th, up from 56th place in 2012. We are 10th in protecting investors, 17th in paying taxes and 28th in registering property. There are still some challenges in terms of dealing with construction permits and import-export trade requirements, but we are working hard to speed up procedures and streamline documentation so that requirements are brought closer to OECD averages. Overall though, Kazakhstan was named as one of the 10 economies improving the most across three or more areas of doing business between 2011 and 2012. And the World Bank has included Kazakhstan in its list of the world’s 20 most attractive investment destinations. By 2016, GDP per capita in Kazakhstan is expected to reach US$15,000, compared with the current level of over US$12,000 — and the country will be classified by the World Bank as a “high income economy.” All in all, these are significant achievements for a country that only became independent just over 20 years ago.

A new world order How is Kazakhstan's economy performing and what is its place in today's global economy?
Rapid-growth markets keep to a safe path After the economic setbacks of 2011, 2012 saw the global economy in recovery mode. However, 2013 is expected to witness a pickup in global economic momentum. Global growth is set to accelerate moderately from 3.2% in 2012 to 3.3% in 2013 and 4% in 2014.1 The uptick in world growth is, initially at least, fueled by rapidgrowth markets (RGMs). Growth in Asian RGMs is set to accelerate from 6.4% in 2012 to 7.4% in 2014, while that in Latin American RGMs should progress from 2.6% in 2012 to 4.5% in 2014. Growth in Middle Eastern RGMs is set to remain robust. In contrast, RGMs in Eastern Europe are expected to lag behind their Asian and Latin American counterparts. Poland is expected to grow by 1.5% in 2013 and 2.8% in 2014 while the Czech Republic is estimated to contract by 0.5% in 2013 and grow by 1.9% in 2014.2 1. World Economic Outlook, IMF, April 2013. 2. Ernst & Young’s Rapid-Growth Markets Forecast, April 2013. Mature economies grow slowly, but still account for half of global GDP In contrast to RGMs, the major advanced economies performed disappointingly in 2012. This was driven by the recession in the Eurozone and Japan. Their recovery is set to remain weak in 2013. Nevertheless, improving bank balance sheets and stronger consumer finances have brought the US back on track. Overall, the advanced economies should play a reduced role in the global recovery, growing at 1.2% in 2013 and 2.2% in 2014.3 Although growth in the major advanced economies has been much slower than in RGMs, they still hold 50.1% of world GDP (in terms of purchasing power parity).4
Kazakhstan in the world economy Kazakhstan was one of the fastest-growing economies in the world between 2000 and 2010. While many parts of the world were reeling with the effects of the 2008 global financial crisis, followed by sluggish growth, Kazakhstan continued to deliver impressive results. However, a combination of factors, including subdued external demand, weaker metal prices and a decline in agricultural output, have resulted in slower growth of 5% in 2012.5 Nevertheless, Kazakhstan was the front-runner in the CIS region. Growth in Russia last year was 3.4% and Ukraine expanded 5. Ernst & Young’s Rapid-Growth Markets Forecast Spring Edition, April 2013, Ernst & Young, 2013. by just 0.1%.6 Looking ahead, Kazakhstan’s GDP is expected to accelerate at 6% in 2013, 7.5% in 2014 and 7.1% in 2015. Over the next two years, its economy is expected to outperform most of the other RGMs. According to Ernst & Young’s Rapid-Growth Markets Forecast, only India and China are set to grow quicker over the next two years. Strong growth projections for Kazakhstan are predicated on high commodity prices, strong infrastructure spending and improved grain harvests. Kazakhstan’s oil production and exports are set to get a boost from the giant Kashagan oil field coming on stream in the near future.

Beyond natural resources Unsurprisingly, a large majority of respondents think that oil and gas, and mining and metals will dominate future FDI inflows in Kazakhstan. The oil and gas sector has been the cornerstone of Kazakhstan’s growth, with its share of the country’s GDP growing steadily from 3.7% in 1997 to 14.7% in 2006, and up to 25.8% in 2011.39 Oil production stood at 79.2 million tons in 2011. The development of new oil fields and an increase in production capacity will enable it to produce 130 million tons of oil by 2020. Such progress would position Kazakhstan among the world's top five oil-producing nations.40 The country’s natural gas production stood at 40 billion cubic meters in 2012, an increase of 2% from 2011. It aims to increase production to 110 billion cubic meters by 2030.41 Similarly, the mining and metals industry plays an important role in Kazakhstan’s economic growth, accounting for approximately 27% of Kazakhstan’s GDP.42 The country has 30% of the world’s reserves of chrome ores, 25% of manganese ores and 10% of iron ores. It 39. “Energy Sector,” Embassy of the Republic of Kazakhstan to the United States website, www.kazakhembus.com, accessed 13 February 2013. 40. The Ministry of Oil and Gas of Kazakhstan website, www.mgm.gov.kz, accessed 20 March 2013. 41. The Ministry of Oil and Gas of Kazakhstan website, www.mgm.gov.kz, accessed 20 March 2013. 42. “Mining Industry,” Embassy of the Republic of Kazakhstan to the United Kingdom website, www.kazembassy.org.uk, accessed 25 February 2013. is the 3rd-largest producer of titanium in the world, 7th in zinc production and 13th among global iron ore producers.43 With only 10%–15% of Kazakhstan’s explored reserves currently in operation, its metals and mining industry has huge potential for further growth. The Government promotes the sector’s development by encouraging FDI and maintaining direct and indirect interests in large mining companies. In 2010, it included the mining sector in the state program on accelerated industrial and innovative development. The program aims at attracting increased FDI inflows and creating a substantial number of new jobs in the sector by 2014. Sectors on the rise Kazakhstan’s Government acknowledges the need to diversify its economy, and is promoting initiatives and policies to improve knowledge-based industries so that they become more competitive. As a result, investors are finding that a more diverse range of sectors are beginning to emerge as attractive investment options. Respondents highlight private and business services, life sciences, real estate and telecommunication as sectors that will offer opportunities in the future. As diversification efforts intensify, the importance of these sectors is set to grow. A good example in this regard has been set by the Gulf Cooperation Council (GCC) countries, which have solid experience in diversification efforts. Here, government attempts to ease their reliance on the volatile oil and gas sector have led Investors to see beyond energy projects. In the region, there is a clear shift toward more strategic and knowledge-driven sectors. The governments in GCC countries have created an environment that allows these sectors to flourish. For instance, they have established financial free-trade zones, health care cities and e-government initiatives. The result is a substantial inflow of foreign capital into knowledgedriven sectors.44 Between 2003 and 2011, the services activity attracted more than half of total FDI projects in the Middle East. • Business services and technology Fifteen percent of investors expect business and private services to be key contributors to FDI in Kazakhstan in the next three years. Hi-tech and telecommunications is seen as a sector that will drive future FDI growth by 6% of respondents. A higher level of broadband penetration and mobile connection than its neighbors, makes Kazakhstan a potential platform for IT and business services in Central Asia. The banking and insurance sector is expected to recover after suffering from the effects of the world financial crisis. Many global high-technology companies — Cisco, HP, LG, Microsoft and Samsung, among others — are already present in the country. Many of such companies help develop the local IT industry, cooperate with local technical universities and bring the latest IT trends and innovations to Kazakhstan. However, business services firms often cite the lack of necessary skills among the labor force as a major hindrance to growth in this sector. The technical qualifications offered by universities and colleges do not reach industry requirements. According to the WEF Global Competitiveness Report, Kazakhstan ranks 103rd out of 144 countries for the quality of its management schools. Only a small portion of IT firms in Kazakhstan seem to innovate effectively. This shortcoming is demonstrated by the lack of patents filed by these firms. According to the OECD Country Capability survey, 45 the majority of ICT firms in Kazakhstan have not filed a patent since 2006. In order for this sector to develop and become more competitive, Kazakhstan needs to unlock the potential of its human capital, stimulate innovation, and improve its institutional environment. • Life sciences According to the Ministry of Industry and New Technologies, the pharmaceutical industry produced US$198m worth of products in 2012, which is about 0.2% of the total GDP for that year.46 However, the expanding middle class and a developing health care system are set to increase pharmaceutical demand in Kazakhstan. As of 2009, Kazakhstan imported 90% of the total drugs consumed in the country, indicating a substantial fund flow out of the country.47 In order to support the development of the sector and increase the share of locally produced drugs, the Ministry of Industry and New Technologies is implementing the 45. “Competitiveness and Private Sector Development,” Organization for Economic Co-operation and Development (OECD) website, www.oecd.org, accessed 10 February 2013. 46. The Ministry of Industry and New Technologies website, www.mint.gov.kz, accessed 20 March 2013. 47. “Pharmaceutical industry,” Invest in Kazakhstan website, invest.gov.kz, accessed 8 July 2013. Pharmaceutical Industry Development Program 2010–14. It also intends to create jobs through diversified growth and keep health care costs in check. A number of global pharmaceutical companies entered the growing Kazakhstan market in the last few years. Among them are Poland-based Polpharm, Turkish-based Abdi Ibrahim and Nobel Ilac, and French-based Sanofi.
Real estate and construction Poor transport and logistics infrastructure is often cited as a barrier to operating in Kazakhstan. However, the rapid development and modernization of transport infrastructure has been underway since 2010. The Government plans to spend around US$19b on transport infrastructure by 2014, especially on links from China to Europe, which will be crucial to facilitate cross-border trade. Further, Kazakhstan’s state railway monopoly, Kazakhstan Temir Zholy, expects to invest more than US$40b in domestic railway expansion projects by 2020.48 The residential construction sector is also growing. In 2012, 6.742 million square meters of housing space was commissioned, an increase of 3.2% on 2011. The Government initiated the Housing and Utilities Sector Modernization Program 2011–2020 to repair condominium facilities. It also launched the Affordable Housing 2020 program in 2012.49 • Agriculture One in 10 respondents are confident about the agricultural sector’s future FDI prospects. Agriculture contributes 5.5% to Kazakhstan’s GDP and employs more than 20% of the labor force. Kazakhstan is already among the world’s major wheat and flour exporters.50 The country is also among the largest grain exporters in the world and exports to over 70 countries, including those in the CIS, the Middle East, North Africa and the European Union.51 Despite the potential and opportunities offered by the sector, it is weighed down by low productivity. There is little knowledge of modern farm management and marketing techniques, and low labor efficiency. According to the World Bank, Kazakhstan’s labor efficiency in agriculture is lower than in Eastern Europe, Russia and Ukraine.52 The Government has adopted the Agribusiness-2020 Program and plans to invest US$20b from 2013 to 2020 to reform the sector. The Government aims to boost agriculture production 48. Kazakhstan rolls out new roads, CNN, 13 September 2012, Building products quarterly briefing, Ernst & Young, February 2013. 49. Committee for construction, Housing and Utilities of the Ministry of Regional Development of the Republic of Kazakhstan website, www.ads.gov.kz, accessed 20 March 2013. 50. “Agriculture Sector,” Embassy of the Republic of Kazakhstan to the United States website, www.kazakhembus.com. 51. Invest in Kazakhstan website, www.invest.gov.kz, accessed 7 July 2013. 52. “Agriculture Sector,” Embassy of the Republic of Kazakhstan to the United States website, www.kazakhembus.com, accessed 25 February 2013. by 150%, improve labor productivity by 300% and increase agricultural exports by 20%.53 Kazakhstan’s vast arable land gives it the opportunity to produce natural, ecologically sound food. It is, therefore, well placed to benefit from the boom in global demand for food. The share of GDP provided by its agriculture sector could rise fivefold by 2050. With increasing development in agri-business, the demand for modern equipment and logistics facilities is likely to increase, offering opportunities to manufacturers and distributors. Furthermore, the need for credit availability is expected to increase, opening doors for a wide range of financial institutions as well. • Automotive and transportation Automotive vehicle production in Kazakhstan grew by 260% in 2010 and 112% in 2011, and sales increased by 14% and 31%, respectively. Lada cars assembled in Russia and Kazakhstan lead sales figures, with more than 40% market share. Despite a morethan-threefold increase, domestic production volumes remain relatively low, with more than 80% of the demand for light vehicles in Kazakhstan met by imports.54 Car imports to the country dropped almost 75-fold in 2012, as 119,809 cars were imported to Kazakhstan in 2011 compared with only 1,599 from January to November 2012.55 This decline is linked directly to higher custom duties, which the governments of Customs Union member states imposed in a bid to limit car imports and improve the local car manufacturing industry. Furthermore, the Government of Kazakhstan is making efforts to attract large automobile manufacturers with the most advanced technology and management. This would help create new production lines in the country. Toyota signed a Memorandum of Understanding (MoU) with the Government of Kazakhstan to begin manufacturing of its Fortuner SUVs in 2014 at the Saryarka Avtoprom automobile plant in Kostanay city.56 Renault-Nissan, together with Russia's largest automaker OJSC AvtoVAZ, is also considering the possibility of assembling cars in Kazakhstan.