As the United States is engaging in regime change in Iraq, the political turmoil in the Middle East is driving up the oil prices. Kazakhstan is flush with oil and gas revenues. However, without targeted government policy, the long term economic consequences of the hydrocarbon boom may lead to crowding out investment in the non-petroleum sectors and appreciation of the Kazakh currency, the tenge. If President Nazarbaev's administration will continue to preside over increases in income disparities and underdevelopment, it eventually may face political instability due to inflated popular expectations. Kazakhstan has done little to prevent the Dutch disease, despite warnings from the World Bank.

BACKGROUND: According to government statistics, Kazakhstan is boasting an impressive 9.8 percent economic growth rate in 2002. It further expects GDP to grow at annual rates of 6.3-8.6 percent in 2004-2006, with total growth of over 27 percent in the next four years. Whether this ambitious target is achieved depends on volatile energy prices and the quality of national economic management in Astana.

According to President Nazarbaev, who spoke at the recent Kazakh-Italian business forum in Rome, Kazakhstan's projected economic growth for the first quarter of 2003 is 9 percent. Italian investment in Kazakhstan reached $1.3 billion dollars. But this is barely a drop in the ambitious goal of $100 billion in investment funds Nazarbaev wants to attract in the next 10-12 years. Kazakhstan may be interested in working with the Italian state-owned ENI, the operator of Agip-led consortium in the Kazakh sector of Northern Caspian, and of the giant Karachanganak field, to export oil via Iran. If such investments materialize, experts say, they will flow overwhelmingly to the overheated oil and gas sector.

Oil revenues continue to remain in record territory for 2003. Kazakhstan has boosted oil production by 16.6 percent in 2002, to 42 million tons. International oil majors, such as Shell and Hurricane oil have significantly expanded their Kazakhstani holdings. Natural gas production and downstream production will also grow: Kazakhstan has increased natural gas exports by 13.2 percent, and produced 30 percent more of gas condensate. Kazakhstan will be developing Phase Three of the Karachaganak gas condensate field, which will require a $2 billion investment. The Amangeldy field in southern Kazakhstan will be expanded, and ChevronTexaco will open a polyethylene plant in April 2003. ExxonMobil is planning to develop a strategic program for Kazakhstan jointly with the Energy Ministry for years 2003-2010. The first iteration of the program will be submitted to the government in the third quarter of this year.

Kazakhstan is boosting its hard currency and gold reserves, which grew by 9.1 percent to $5.5 billion in January, and further increased the National Fund to $1.933 billion, while gold reserves grew by 14 percent to $627 million, according to the Kazakh Central Bank press release quoted in the February Interfax Central Asian Business Report. The Central Bank said that Tenge money supply tripled, foreign deposits rose by 32.8 percent, and bank deposits increased by 46.2 percent, while lending rose 37 percent in 2002.

Using growing demand for energy, Kazakhstan announced plans to become the world's largest uranium producer by the year 2027. Its national nuclear corporation, Kazatomprom, has increased the ore production from 794,000 tons in 1998 to 2.4 million tons in 2002. As it currently produces only five percent of the global output, the goal to become number one seems excessively ambitious. Kazakhstan has increased uranium production by 34 percent in 2002, and is planning to expand export to China, Japan and Russia.

Astana is also interested in boosting its coal production from 70 million tons in 2002 to 74 million tons in 2003. The January 2003 figures are higher than January 2002 by 21 percent.

IMPLICATIONS: This natural resources windfall is the strategic window of opportunity for Astana to address four structural defects of its energy-driven economy: corruption; capital flight; a dysfunctional social safety net; and the money-losing nature of the non-extracting sectors of the economy.

High-level corruption and capital flight may be the most difficult to resolve. Most often perpetrated, or aided and abetted, by top government officials, it is a net loss to the people of Kazakhstan. Police measures are in themselves not effective, as law enforcement is corrupt and controlled by the perpetrators. The fish is rotting from its head. The government is unlikely to crack down on organized crime and corruption which plague the economy. As long as the government is not prosecuting the most odious "exporters" of capital, even if they are politically connected insiders, the local economy will remain too inhospitable - and bureaucracies too corrupt - to make investment in non-energy sector attractive.

Second, it is the time for the Kazakhstani government to bring internal energy prices, including natural gas and coal, to world levels. Today's high oil prices will allow to provide subsidies to retired or laid off workers, while closing down inefficient, energy-guzzling enterprises and hiking railroad tariffs. Energy can be exported to increase revenue. Some of the workers in remote "company towns" can be relocated to more livable venues.

Third, social sector reform is long overdue. While salaries are higher in the energy sector by a factor of at least two in Kazakhstan, most of the gigantic profits are not invested back home to create jobs outside of the oil and gas sector, nor are tax proceeds efficiently distributed to support the elderly, sick and poor.

CONCLUSION: The Kazakh government can battle the Dutch disease by stimulating non-energy business development and job creation, by simplifying registration for new business and reducing corporate taxes and employment payments for these newly created entities. As USAID and a number of NGOs repeatedly demonstrated around the world, micro-lending to boost entrepreneurship is yet another way to decrease unemployment and poverty.

In addition, some of the structural unemployment - 20 percent in Kazakhstan, even higher in energy-poor Kyrgyzstan and Tajikistan - can be alleviated by opening the doors of the oil and gas sectors to workers from the areas hit with particularly high unemployment. This can be achieved by loosening severe interior ministry residence registration rules, which are a hick-up of the old Soviet era "propiska" system, and by providing better living conditions in the company towns owned by the extracting industries. As World Bank Vice President Johannes F. Linn has suggested recently, regional cooperation is likely to alleviate some of the structural asymmetries and stimulate growth. Clearly, cooperation on water utilization, pipelines, transport, and commerce is the most logical.

Unequal income distribution in Kazakhstan, where average salary is barely over $1,000 a year, (and even more so in Kyrgyzstan and Tajikistan with only $200-$300 per capita incomes), may lead to economic dislocation, social conflict, and uncontrolled migration. Kazakhstani leaders were forewarned. Both Astana and international financial institutions should address these disparities while the energy bonanza lasts.

AUTHOR'S BIO: Ariel Cohen, Ph.D., is Research Fellow in Russian and Eurasian Studies at the Heritage Foundation and author, with Gerald P. O'Driscoll, of "The Road to Economic Prosperity for Post-Saddam Iraq" (2003). His expertise includes international energy security.

This piece was originally published on the Central Asia-Caucasus Institute website.