Nazarbayev cornered

The scandal that has become known as "Kazakhgate" refuses to die down despite the Kazakh government's best efforts to suppress it. The affair, concerning the funnelling of millions of US dollars from oil sales into secret offshore bank accounts, has already had destabilising consequences and risks escalating further.

US businessman James Giffen, chairman of Mercator Corporation, was indicted on April 2nd on counts of conspiracy to violate the Foreign Corrupt Practices Act (FCPA, 1977) and of actual violation of the act. The FCPA forbids US nationals, residents and institutions to use bribes in order to obtain commercial advantages or gains. Mr Giffen's arrest is significant because it brings the Kazakhgate affair - a small but persistent thorn in the Kazakh government's side since 2000 - one step closer to the Kazakh president, Nursultan Nazarbayev, himself.

The kickbacks kick back

The seeds of the Kazakhgate affair were sown in 1997, when a dispute among oilmen seeking to do business in the Caspian led an Iranian-born businessman, Farhat Tabbah, to file a law suit in London against three US businessmen - one of which was Mr Giffen - as well as the then Kazakh oil minister, Nurlan Balgimbayev, and a subsidiary of US oil giant Mobil (now ExxonMobil). The law suit caught the US State Department's attention because it involved swaps of Kazakh oil with Iran, in breach of US trade sanctions.

From this seemingly small start, a convoluted series of deals and relationships unravelled, and in 1999 high-ranking Kazakh officials found themselves directly concerned when the Swiss banking authorities discovered irregular transactions. Sums destined for Kazakh government accounts had been transferred, to what seemed to be personal accounts in the name of high-ranking Kazakh officials - including Mr Nazarbayev - through accounts linked to Mr Giffen.

This discovery fed into a series of allegations of corruption against the Kazakh government elite already being made by an exiled Kazakh prime minister, Akezhan Kazhegeldin, and as the affair progressed it became central to the opposition's efforts to undermine Kazakh public support for Mr Nazarbayev. The Swiss authorities handed the case over the US State Department in September 2001, and Mr Giffen's arrest is the result of a two-year grand jury investigation into the transactions surrounding a US$41m deal between Mercator and Mobil.

Links to the top

Throughout the 1990s, Mercator served as an intermediary between the Kazakh government and Western companies. During this period Mr Giffen was one of Mr Nazarbayev's closest advisors, and acquired the nickname "Mr Kazakhstan". It is this close relation to the president that makes his arrest a serious concern to the Kazakh government.

Up until now, Kazakhgate has been only tenuously linked to specific figures in the Kazakh administration, and no misdemeanours have thus far been proved. The secret Swiss accounts, for example, were explained by the government to have been an unofficial oil fund, the contents of which were used to cushion the Kazakh budget from external shocks - such as the Russian financial crisis of 1998.

Yet Mr Giffen's arrest raises the possibility of specific accusations being levelled at Mr Nazarbayev or members of his family and inner circle. A US federal prosecutor has confirmed that Mobil too is under investigation.

On the defensive

The scandal may already have troubled Mr Nazarbayev. In 2000 his parliamentary supporters granted the president lifelong immunity from prosecution. A year later the authorities announced a capital amnesty for returning capital and provided for the scrapping of tax records relating to the period 1995-2000.

The country's drift towards authoritarianism also picked up speed, in response to parliamentary deputies' calls for an explanation of the secret bank accounts. While admitting the existence of the accounts, and claiming that they were Kazakhstan's unofficial oil fund, the authorities also stepped up the repression of media and political freedoms. Independent journalists were consistently harassed, regulations covering political activity and party registration were tightened, and prominent members of the opposition - once elite insiders themselves - were imprisoned after highly irregular trials.

The worst is yet to come

Pragmatism suggests that Mr Nazarbayev has little to fear from further investigations, even if they cause him greater embarrassment. After all, he has wisely backed the US-led war on terrorism and has granted US and western companies leading roles in developing Kazakhstan's crude oil reserves - which are among the largest in the non-Middle Eastern world. Nevertheless, Mr Nazarbayev and his allies are right to be concerned.

Maintaining good relations with the US is important to Kazakhstan primarily for economic - and, more specifically, oil-related - reasons. Good relations with the US serve as a backdrop for attracting US investors. Yet in recent years, US investors in Kazakhstan have not had an easy time. High oil prices have emboldened the Kazakh government to revise the "sweetheart" deals struck in the early 1990s from a position of weakness. A new investment law has also rewritten the rules of engagement to Kazakhstan's benefit. Of particular concern are clauses undermining foreign investors' right to international arbitration.

The Kazakhgate affair is likely to make the situation even worse for oil companies, since they will henceforth - or at least for some time - have to be especially vigilant about the payments they make to Kazakh officials. Since corruption is endemic and without it the wheels of the state apparatus are hard to move, this will create even more day-to-day operational difficulties for foreign investors.

Kazakhstan's oil reserves and strategic location will make the US administration unlikely to want to freeze US-Kazakh relations over the Giffen affair. Nevertheless, Kazakhgate sets the stage for a marked cooling in relations, since at issue is not just corruption but also the violation of US sanctions against Iran. The deterioration in the business climate, coupled with a shift in the focus of US foreign policy from Afghanistan to Iraq - a far larger oil producer than Kazakhstan - could combine to severely diminish US interest in the central Asian country.

Backing into a corner

Yet the most important repercussions of Kazakhgate for Kazakhstan are domestic. At independence, Mr Nazarbayev essentially preserved the Soviet system as it was under 'perestroika' - allowing only heavily circumscribed freedoms. Yet the fate of the Soviet Union shows clearly that limited freedoms create a pull towards ever greater freedoms. Mr Nazarbayev appears to have decided to avoid the economic and political collapse of the system he presides over by responding to demands for greater freedoms with restrictions on existing ones. Journalists and politicians who insist on bringing up the issue of corruption in high places have tended to find themselves in prison. The strong suggestion is that human rights abuses are on the increase in Kazakhstan, while civic and political freedoms are declining.

Mr Nazarbayev has few choices. He might not be able to survive a second systemic upheaval - strong enough business and regional interest groups have arisen to pose a real challenge in genuinely free and fair elections. Kazakhgate narrows his options further by suggesting that the current economic hardships of the Kazakh population - living standards look decent only when compared to other, even poorer former Soviet republics - are the result not just of a difficult economic transition, but of the authorities' exploitation of Kazakhstan's resources for personal gain.

In the immediate term the scandal will therefore have the opposite effect an observer might assume, leading the government to close ranks and tighten its controls on the population. However, there are questions as to the sustainability of this approach.

First, Mr Nazarbayev and his government have been battling with Kazakhgate for three years already, without managing to silence the affair - the fact that it is an international issue is crucial in this respect.

Furthermore, the existence of an opposition in exile - and therefore up to date with developments - and its links to the domestic opposition also makes the government's task more difficult. The government can silence individual critics, but Kazakhgate provides a common issue that the fractious opposition can agree on, and - more importantly - acts as a wellspring for new dissent.

Not a fatal blow, but perhaps a decisive one

The experience of the Ukrainian president, Leonid Kuchma, has shown that a strong, autocratic president can weather many storms. However, Mr Kuchma's survival against all the odds also carries a warning: the autocrat can hold on to power, but this does not prevent his increasing isolation. Boris Yeltsin, beloved of the Russian public, left the presidency in opprobrium, precisely as a result of persistent Kazakhgate-style rumours surrounding himself and his family.

The corruption allegations will not topple Mr Nazarbayev any time soon. However, if Kazakhgate continues to surface periodically, it may yet prove the difference between being president for life and being forced to look for a dignified way out, following in the steps of Messrs Kuchma and Yeltsin.

Economist Intelligence Unit - ViewsWire, Number: 301, 2003