Effect of Global Financial Crisis

5.1 Transmission Channels

While the main channel for transmission of the Russian financial crisis to Central Asia was through trade links, the global crisis impacts the region directly through the financial illiquidity in the global markets. The most affected of the countries in the region is Kazakhstan which had fuelled its rapid growth through heavy private sector external borrowing from foreign capital markets. Kazakh banks balance sheets are estimated to have 50% in foreign liabilities²⁷ which, during the boom period, were plowed into the economy to finance major construction, real estate, and extractive industries. Similar to how it was in Asia (in 1990s) and in the US (recently), huge inflows of foreign finance fuelled a real estate bubble starting mid-2007. Now, when capital dried up from the global financial crisis, Kazakh banks are scrambling for new financing, both to finish off many real estate and construction activities as well as to pay off their maturing debts.

The transmission channel of the global financial crisis to the rest of Central Asia is through Kazakhstan's banking subsidiaries that operate in other Central Asian countries, particularly in the Kyrgyz Republic where nearly half of the banking system is owned by Kazakhstan banks. As the Russian and Kazakh parent banks of these subsidiaries struggled, the subsidiaries also wobbled through lack of funding, creating financial strain in other parts of the region. Thus, even countries that were not linked to the foreign financial market were caught up in the mayhem in the global markets through the troubles of the foreign-owned subsidiaries. Already, the Kyrgyz Republic had experienced a credit slowdown as a result of the banking sector difficulties in Kazakhstan.

In Kazakhstan, around 70% of bank loans are connected directly and indirectly with real estate. These loans, in turn, were funded not from domestic deposits but from foreign debt which now amount to 4.8 trillion tenge (approximately US$39 billion.)²⁸ Now shut off from international capital markets, and facing difficulties in rolling over their external debt, Kazakh banks with high exposure to international capital markets are the most badly hit. Further, Kazakh banks' exposure to the declining Russian real estate market, along with the weakness of the Russian ruble make them susceptible to further balance sheet pressure. The increase in provisioning for the potential losses from real estate and nonperforming loans, as well as for the maturing foreign debt has created illiquidity in the lending market and tightening of lending requirements.

The other channel of contagion is the drop in remittances of migrant workers, mostly from Tajikistan and Kyrgyz Republic, working in Kazakhstan and Russia. As the economic growth in these two countries stumbles, migrant workers that benefited from the construction boom find themselves out of work and had to return home, thus contributing to the rise in domestic unemployment. In countries that have become heavily dependent on foreign remittances—Tajikistan, for example, received remittances equivalent of 50% of its 2008 GDP (IMF 2009)—the drop in this foreign financial flow is equivalent to a major external shock. The projected 30% decline in remittances in Tajikistan threatens to affect poor and vulnerable households. It will likewise have an adverse impact on the profitability of Tajik banks because of the drop in associated fees from remittances. Bank fees from remittances constitute about one third of Tajik bank income.

Although commodity prices have not reached the nadir it did in the 1990s, the weakness in commodity prices is additionally impinging on the commodity export dependent economies of Central Asia (Kazakhstan, Turkmenistan, and Uzbekistan). The lower export revenues lessen the emergency fund that they can use to boost domestic demand in the face of a sluggish global market. On top of the terms of trade deterioration, weak global demand, for cotton, aluminum, and other metals (except gold), is further exacerbating growth declines in these countries, including Tajikistan.

5.2 Macroeconomic Effects

Macroeconomic effects, so far, have been seen mainly in Kazakhstan, the most globally linked of the Central Asian countries. In 2008, Kazakhstan grew by 3.2%, a decrease of more than five percentage points from its 2007 growth rate. For the rest of the Central Asian countries, the 2008 growth rate shed between 0.5 to 2.0 percentage points from their 2007 growth rate. In 2009, the prediction was more dire with a negative growth rate projected for Kazakhstan and very low growth expected for Tajikistan and the Kyrgyz Republic. Turkmenistan and Uzbekistan are expected to achieve real gross domestic product (GDP) growth of 7% because of favorable developments in the hydrocarbon sectors. Exchange rate depreciation, caused by asset switching in favor of safer foreign currencies, and higher food and fuel prices are expected to contribute to higher inflation. The external dimension of the crisis and weak global demand is reflected in current account projections that shift from surplus in 2008 to a small deficit in 2009. The International Monetary Fund (IMF) notes that while the energy exporters from Central Asia would see their current account surpluses evaporate due to falling commodity prices, the energy importing countries would narrow their current account deficit because of tightening financing conditions. Similarly, the fiscal position is moving from a surplus into a deficit.

Table 7: Selected Macroeconomic Indicators (2007–2009) [ PDF 55.2KB | 1 page ]

5.3 Effects on Trade Finance and SMEs

As the banking sector becomes illiquid, the story unravelling now looks similar to the previous Russian financial crisis. The financial market is characterized by deleveraging commercial banks, a sharp rise in risk aversion, and increasing numbers of bank failures. Trade finance is again among the financing facilities that show signs of tightening. An IMF survey²⁹ of banks showed that prices of lending facilities, including L/Cs, have risen, partly due to higher cost of funds and partly due to higher capital requirements and rising default risks. Banks, moreover, see the price trend continuing in 2009. The volume of trade transactions from emerging market banks had declined by an average of 6%. Emerging markets are most affected by the rising costs and increased risk perception because the products they ship tend to be low-margin products, usually as part of the global value-added supply chains. The increase in trade financing cost eats up a huge portion of their narrow margin. The survey also reported that banks had tightened guidelines for some specific countries.

5.3.1 Funding Sources of SMEs

While there is scant data on the effect of the global crisis on SMEs in Central Asia, I try to assess the potential effects using the SME characteristics I obtained from the 2005 BEEP Survey.³⁰ The idea is to uncover some financing structure from this survey and derive relevant implications that can apply to the current crisis. The survey was again conducted using stratified sampling similar to the approach taken for the 1999 BEEP Survey.

Figure 6 [ PDF 75.8KB | 1 page ] shows the financing sources for working capital of enterprises in Central Asia. All firms show that the majority of the working capital requirements were sourced internally, while the remaining 12 to 20% were externally funded. Of the external sources, all firms relied heavily on bank borrowings, both from the government and private sector, as well as trade credits. Small enterprises, however, relied relatively less on government banks loans compared with medium enterprises. Moreover, SMEs had a heavier reliance on family loans which large enterprises did not. On the other hand, large enterprises relied more heavily on foreign bank borrowings than SMEs.

From this basic analysis, the implication is that while both SMEs and large firms would be affected by the global financial crisis through the impact on the liquidity of the banking system, large enterprises would likely be harder hit than SMEs because of their heavier reliance on foreign financing, as foreign investors and lenders are now more highly risk averse due to problems in the foreign capital markets.

To further analyze the differential impact of the crisis on various enterprises, I divided the groups into SME exporters and non-exporters, as well as large exporters and non-exporters. Exporters are those firms with more than 20% of their sales accounted for by direct exports.³¹ Figure 7 [ PDF 101.3KB | 1 page ] shows that large exporters relied relatively more on private and government bank borrowings than SMEs. Further large exporters relied more heavily on foreign bank borrowing compared with large non-exporters. SME exporters, on the other hand, relied more on other sources of finance, like state-owned banks, family loans, supplier and consumer credits, leasing, and loans from informal sources than large exporters.

Large exporters stand to suffer from illiquidity in the global financial markets more than non-exporters because of their heavy reliance on foreign borrowing. Large exporters source almost 7% of their working capital requirements from foreign borrowing compared with less than 1% for large non-exporters.

Since retained earnings is a large source of working capital, the global financial crisis affects all enterprises' financing source through its effect on economic growth and sales. If sales drop, earnings will also drop, thus affecting a huge source of working capital for all enterprises. For exporters, a drop in foreign sales may be offset by the depreciation of the local currencies which increases the amount of their total revenues (in local currencies). Exporters also benefit from a more diversified market, as even if some foreign markets experience demand weakness others may compensate, compared with non-exporters that are limited to the domestic market alone. Large exporters may benefit from the rise of commodity prices because most large exporters are in the extractive industries, while SME exporters, which are usually in manufacturing and the retail/wholesale trade business, may be more direly affected by the weakness in domestic and foreign demand.

5.3.2 Nonbank Funding Sources

Firms usually use sources of finance other than the banking sector through the mode of payment to suppliers or from customers. In particular, advance payment by customers is a form of cheap credit for the producers and is a help in lessening working capital pressure. Similarly, delayed payment to suppliers is another form of credit. In this sense, how much advance payment the producers can source from customers, or how much delayed payment it can negotiate with suppliers may provide some implications on pressures that the global financial crisis can impose on firms.

Figure 8 [ PDF 97.3KB | 1 page ] indicates the relative share of advance payment, cash payment, and suppliers credit in the previous years input purchases of the respondents. It reveals that whether they are SMEs or large firms, enterprises in Central Asia have to transact either in cash for input purchases or provide advance payment. Supplier credits were as little as 10% of total purchases of SMEs (15% for large firms), while advance payment is close to 50% of input purchases for large firms. More than 50% of SME purchases were paid in cash. For SME importers, the advance payment requirement is even higher than the SME average.

The relative importance of prepayments and cash payments as a share of purchases implies that all enterprises would need larger working capital finance or bridge financing to be able to pay for the inputs they need for production. Either this, or input suppliers would be forced to grant more supplier credits to continue operations. However, considering the high risk associated with sales to Central Asian importers, an increase in suppliers credits from foreign suppliers may be difficult to negotiate given the current global economic situation. For SME importers, the need for advance payment may be attenuated by the existence of trade guarantees, either from the government or from international donor agencies.

The situation is relatively less stark if we look at the mode of payment by consumers (Figure 9 [ PDF 100.4KB | 1 page ]). In this case, SMEs' financing need is decreased by the fact that a large share of their sales are paid in advance or upon delivery. This is particularly true for SME exporters, despite performance or delivery risk concerns for exporters from emerging markets generally. SME exporters get 55% of their sales paid in advance compared with 29% for non-exporting SMEs. Large firms have similar payment structures regardless of whether they export or not— receiving roughly 40% of sales through advance payments.

The potential risk from the global financial crisis, given this payment structure on sales, is that the depressed global demand might reduce the capacity of foreign buyers to make advance payments leading them to demand more credits from exporters from Central Asia. Unlike the manufacturing trade, where alternative financing may be arranged between companies because of the vertical relationships of the exporter and importer,³² trade in commodities tends to be more volatile and usually goes through organized commidities exchange markets and is, thus, highly dependent on bank-based financing. In turn, the inability of firms engaged in commodities trade to collect payments and obtain financing may have significantly contributed to their default on their own bank loans.

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