The head of EDB gives an interview to the KazTAG international news agency

Dmitry Pankin: EDB to increase its loan portfolio by 30% in 2016

Astana. 1 March 2016. KazTAG, by Zhanbolat Mamyshev. What impact has the "devaluation parade" in the Eurasian Economic Union (EEU) countries had on large-sized enterprises and their financial standing? To what extent are EEU companies interested in doing business in neighbouring member states and payments in national currencies? Dmitry Pankin, Chairman of the Management Board at Eurasian Development Bank (EDB), answers these and other questions in an interview to KazTAG.

Q.: Are you satisfied with EDB's performance in 2015?

A.: In the past year, our performance was slightly better than we had expected. The key financial indicator of the year was, nevertheless, negative – a loss of approximately US $128 million. When I joined the bank last March, I initiated audit of the loan portfolio. We found out that provisions needed to be increased by US $200 million. In other words, our total provisions for bad projects grew almost fivefold. This is the main cause of negative performance in the year.

The shrunk investment portfolio is obviously a concern. The first reason for this is foreign exchange differences since many loans were provided in tenge and roubles. Devaluation has impaired rouble and tenge loans. The second reason is that when I joined the bank, it did not have good new projects in the pipeline. Most of them were economically groundless. So, we had to revise approaches to projects. Now we have a new project portfolio we'll work on this year.

For example, EDB plans to invest over US $1 billion in Kazakhstan's economy until the end of 2016. These will be investments in metallurgy, mining, transport infrastructure and other sectors.

Q.: How has your loan portfolio changed over the last year? Did you provide tenge loans?

A.: The loan portfolio decreased by approximately 35%, to US $1.8 billion. Previously, EDB issued tenge bonds, which were purchased by the pension fund, and financed projects. In 2015 this scheme was suspended and all our potential borrowers who wanted to borrow in tenge remained unfunded.

Q.: I've heard that the new team is working actively on non-performing loans. Who are the main non-payers in Kazakhstan? What do you plan to do?

A.: In the first six months of 2015, we identified a host of troubled loans. We're devising our strategy for the future and are in the process of negotiations. If collateral has been provided, we try to foreclose and sell it. If the project is viable such as, for example, Ekibastuz GRES 2, we agree to restructure the loan.

If there's "no money, no grain," as with Ivolga Holding, we initiate litigation. At present, EDB has all legal grounds to continue bankruptcy proceedings against Ivolga Holding. However, we understand that the facilities of the holding, which owes EDB over US $90 million, are of social importance and would agree to a reasonable compromise. EDB is ready to consider assignment of its claims against the holding to third parties, in accordance with the current laws and for the sake of Kazakhstan's agro-industrial sector.

In 2012, TsVS-Yeskene was provided with a loan to build a railway tank car repair plant. The plant has never been built and its debt of US $22 million is most probably unrecoverable. I think it's obvious that we do have problems here.

We have another debtor, Merkur Dom Invest, a woodworking plant, which is not operable. We consider arranging a public auction to sell its property.

Q.: Why have these enterprises become debtors? Is this because of devaluation?

A.: I would not blame everything on devaluation. Ivolga Holding's management, for example, is so poor that this cannot be explained by the bad economic situation. However, the tank repair plant in Yeskene, which oriented on Caspian fields, was affected by falling oil prices and, accordingly, worsened performance of oil businesses at the Caspian Sea. The market's demand for tank car repairs went down correspondingly.

Q.: Do most clients manage to repay their loans?

A.: Yes, most do. We have many projects that pay both interest and principal on the loans, but we also see that businesses do not generate income. In such cases, despite good balance sheets, we consider such projects as risky.

Q.: If previously there were certain drawbacks in management and critical approach to the bank's clients, what do you do in this respect now?

A.: Our main task now is to build the project cycle. What was the problem with it? I believe that many projects appeared accidentally, because of acquaintances or personal sympathy. What is our idea now? It is to build a project cycle based on a robust analytical platform. Our research identifies economic areas and sectors of potential interest, with possible integration effects. Then our customer managers will approach these sectors.

We have regrouped the bank's entire work into several blocks. The first is the search for a sector of potential interest. The second is the front office of project managers who approach potential clients. Their task is to begin work with a client and prepare preliminary loan proposals. Then the structural block joins the process. It negotiates loan agreements and prepares credit documents. Then the risk management department steps in to analyse "hidden reefs." This scheme works as a multistage filter.

Q.: When will the scheme be introduced?

A.: We have already divided all our project specialists into two blocks: the front office and the structurer. The research department has been launched. We are in the process of recruiting researchers. We'll start the conveyor by the second half of the year.

Q.: EDB has adopted flexible interest rates. What does this mean?

A.: Recently, the management board decided to adopt a flexible system of interest rates. It will allow setting most attractive and competitive interest rates for investment projects in the bank's focus of attention. These are, in the first place, projects aimed at economic integration and deeper industrial cooperation between the member states, as well as national development projects.

Q.: Cooperation between enterprises of our countries is not too widespread at the moment. How is it represented in your portfolio? Are there any positive trends? Are there many such enterprises?

A.: Our current task is to find and develop integration projects. For example, Kazakhstan has Asia Auto, a joint assembly project with AutoVAZ. It is a well-known project, which is covered extensively in the media, and we also take active part in its preparation. However, we have not come to a final decision yet. Why? We are concerned about declining sales in the car market. Is there logic in launching extra facilities while the existing ones are underloaded? The project initiator, Kazakhstan's largest dealer with market knowledge, is a strong advantage in the project. We'll see.

We are also considering interesting telecommunications projects proposed by Alma TV. The company plans to buy several telecommunications companies (broadband internet access, television) in Russia to build a holding. This is an example of an integration project. It has its logic: saving costs by consolidating several small telecommunications companies. In addition, they want to lay a fibre-optic cable between Russia and Kazakhstan and this will also cut costs significantly.

We have several other projects where we'll simply finance supplies. For example, ERG supplies iron ore and aluminium as raw materials for Russian companies. We'll finance their trade supplies. This may be uncharacteristic for a development bank, but what is important to us is the integration effect: a Kazakh company supplies metallurgical feedstock for Russian plants.

Another example is the Aktobe rail and structural steel plant. It purchases high-strength steel parts from Russia to manufacture rails for Kazakhstan Temir Zholy and Russian Railways. We plan to finance their trade purchases in Russia.

Q.: A popular word today is crisis, understood by some as an opportunity. Do businesspeople in our countries have appetite for risks and for work not only in Kazakhstan, but also in Russia and other EEU countries?

A.: The appetite for risk is reasonable, in my opinion. Enterprises have seen 1998 and 2008 and now they have less romanticism such as we'll launch production and everything will be ok. People have begun to calculate risks. Foreign exchange risks are an especially serious concern for those who have liabilities in one currency and proceeds in another currency. They analyse different stress situations and they're right.

However, life goes on and fear won't feed you. I believe that today we do have opportunities to develop business. Yes, oil costs not $100, but $30 and demand in the economy has fallen accordingly, but we had serious devaluations. What does this mean? This means that local expenditure has decreased and domestic manufacture, in the EEU countries, becomes profitable. It becomes more competitive.

Q.: Different countries had different devaluation extents. Some have derived greater advantages with dollar-denominated labour costs or electricity prices, compared to their neighbours. Would it be simpler to introduce a single currency, as proposed by some, or should businesses underwrite their foreign exchange risks when working in neighbouring areas?

A.: There're two ways. A single currency would envision a single macroeconomic and budget policy. In other words, this should be a single country. In this case the single currency would work. With different macroeconomic policies, introducing a single currency would be a mistake.

These discrepancies became very visible in early 2015 when people from Kazakhstan went to Russia to buy goods after devaluation of the rouble. Russia stated that it wouldn't support the rouble and spend its international reserves, and let it float. The rouble went down, but Kazakhstan continued to maintain the tenge and spend its international reserves. It turned, however, that it was impossible to fix foreign exchange rates in the context of the current inter-country relationships.

Belarus has also discontinued to support its currency and now it has a floating rate of exchange. The EDB Centre for Integration Studies has found out that the cross rates of the Belarusian rouble, the Russian rouble and the Kazakh tenge had aligned more or less as a result of all these fluctuations. With free pricing in the foreign exchange market and no interventions on the part of central banks, nothing awful happens and the market balances itself.

Q.: Foreign trade in Kazakhstan was traditionally effected in dollars and euros. Now attempts are made to trade in yuan with China and roubles with Russia, or, in other words, in trade partners' currencies. Is this the case with your clients?

A.: We have analysed trade in the EEU: approximately 70% of all payments between companies are in roubles and 20% in dollars. We believe that national currencies are very actively used in inter-country payments and that dollar fluctuations will only help to promote settlements in national currencies.

Q.: What is tenge's share in overall trade?

A.: About two or three per cent.

Q.: You expressed interest in the Big Almaty Ring Road (BAKAD). Are you still interested?

A.: Yes, we consider an investment of US $100 million. Several development banks work on this project, including the Eurasian Bank for Reconstruction and Development and the World Bank, in addition to EDB. This is a typical infrastructure project for development banks. It has clear parameters: significant traffic, and tangible social and environmental effects. Here, it is important to calculate the tolls carefully and avoid the "Moscow trap": a toll road was built in Russia recently from Moscow to Sheremetyevo but the tolls are so high that drivers prefer the old road and the new road is empty.

Q.: Kazakhstan went for a simpler solution: the first toll road between Astana and Schuchinsk has not alternatives, but the toll is not high – 1 tenge, or approximately 20 Russian kopecks, per kilometre.

A.: It is reasonable.

Q.: China is developing the Silk Road Economic Belt and has a number of projects Chinese investors would like to fulfil in Kazakhstan. Does EDB take part in them?

A.: We are also interested in this project. It proposes to divide the road into several sections, one of which will run from Kazakhstan's border to Orenburg.

Q.: What are EDB's forecasts for inflation and GDP growth in Kazakhstan in 2016? In 2015, inflation reached 13.5%. Will Kazakhstan manage to return to the 6-8% corridor in 2016?

A.: We believe that the average annual inflation in Kazakhstan will be 12.5% (with an upsurge to 15-16% in the first six months) and GDP will grow by 0.5-0.7%. Compared with Russia, this is not too bad. Russia had minus 3.7% in 2015 and this year it will have between zero to minus 1.5%.

Q.: What plans does EDB have for 2016?

A.: I believe we have all the prerequisites to generate profit. We've made all necessary provisions and understand all risky projects. The bank has profit every month. We now plan to increase our current investment and loan portfolio by 30%. I think that our plans are rather prudent. EDB has around forty projects at different stages of consideration and has money to fulfil them. This includes our treasury funds and we can get funds in international markets rather easily. We do have opportunities to enhance the portfolio in a reasonable manner.

The typical ratio of equity to loan portfolios at development banks is one to two, or one to three. We have US $1.5 billion in equity, so we can rather easily target on a loan portfolio of approximately US $3 billion. We have good grounds to expect this growth within two to three years.

Q.: Does this mean that you won't need additional capitalisation in the near future?

A.: I think we won't. Moreover, the countries do not have resources for this. Additional capitalisation was possible when the countries had significant sovereign wealth funds. In Kazakhstan and Russia we considered where to invest these funds. The situation has changed, unfortunately.

Q.: You mentioned foreign borrowings. Do you want to use them?

A.: We traditionally work using this model – we have eurobonds in dollars and rouble-denominated bonds. We use these funds to finance investment projects. Now we have an excess of own funds and don't need to borrow in foreign markets this year. However, if we increase our current portfolio by 30%, the issue of approaching foreign markets will arise as early as in 2017.

Q.: You referred to tenge bonds. Is EDB interested in tenge borrowings?

A.: Yes, surely. We have many potential projects in tenge. We've been approached by Kazakhstan's railways with a number of projects, and there're gasification projects in some regions. For us, it is very important to get financing for these projects in tenge.

In April we plan to sign an agreement with the National Bank of Kazakhstan. However, it will be on financing repo and swap transactions. They are short-term, one-year transactions that won't solve the problem. Therefore, it is important that we are provided with access to the pension fund's resources and an opportunity to place "longer" bonds.

Q.: Does the National Bank express interest?

A.: There's no solution on the long money yet. The plans were announced recently on the use of pension money, envisioning that a portion of them would be used to finance the budget, a portion to buy international reserves, and approximately 600 billion tenge to purchase bonds and finance the economy.

Q.: So, would you like to attract some of this money?

A.: Yes. On our part, we're ready to be fully transparent and show how we spend tenge.

Q.: Thank you for the interview.