Since gaining independence 30 years ago, the five countries of Central Asia--Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan--have benefited tremendously from trade and investment links with their neighbors, China and Russia. China's economic boom over the past few decades has increased its consumption of oil and gas. Its imports from the oil- and gas-rich Central Asian countries have grown accordingly, making it a crucial trade partner for the region. Yet change is afoot. China's transition to a consumption-led from an investment-led growth model will moderate growth in its energy consumption. Using a gravity model of trade, S&P Global Ratings estimates that future exports from Central Asia's countries to China will rise less under a consumption-driven growth model than under an investment-led one, with a gap of 10%-15% between the two.

One potential mitigant is China's plan to achieve carbon neutrality by 2060, as this plan entails greater use of gas, at least in the medium term. Gas imports should therefore continue to increase, benefitting Turkmenistan and, to a lesser extent, Kazakhstan and Uzbekistan. As Turkmenistan and Uzbekistan don't have a common border with China, gas may travel through Kyrgyzstan and Tajikistan, profiting those countries as well. Potentially, China outsourcing manufacturing capacity to Central Asia, and increased demand for consumer goods in China, could also help mitigate the consequences of China's economic rebalancing, although obstacles abound.

China Has Overtaken Russia As The Main Recipient Of Central Asian Exports

The cultural links and value chains between former soviet republics made Russia a major trade partner for the Central Asian countries following their independence. In 1995, more than 30% of the region's exports went to Russia. However, as the Central Asian economies became more integrated with the global economy, their exports began to diversify geographically (see chart 1). This trend was underpinned by the disappearance of the soviet value chains on the one hand, and Central Asia's development of commodity-export capabilities on the other, particularly with regard to the oil and gas sectors in Kazakhstan, Turkmenistan, and Uzbekistan. Fuel exports now constitute 55% of all Central Asia's exports, up from 24% in 1995, while the share of agriculture and food has dropped to 5.5% from 34% in 1995 (see chart 2).

Chart 1

Chart 2

China's increased demand for commodities led it to become a key trading partner for Central Asia. China's investment-led economic boom over the past few decades has relied heavily on imports of commodities, including oil and natural gas. Since 1995, China's consumption of oil has quadrupled, while its consumption of natural gas has increased almost 18-fold, despite the continued dominance of coal (see charts 3 and 4). The increase in China's oil and gas consumption has had especially positive implications for energy exporters such as Turkmenistan and Uzbekistan, which have notable reserves of natural gas, and for Kazakhstan, which has notable reserves of oil as well as natural gas. Central Asian export to China grew from a small fraction, mostly involving merchandise, to around 22% in 2019, with China supplanting Russia as the main destination of Central Asia's exports.

Chart 3

Chart 4

Tajikistan and Kyrgyzstan mainly export metals to Europe, while Turkmenistan, Kazakhstan, and, to lesser extent, Uzbekistan, export oil and gas also to China (see chart 5). The size of the exports also varies significantly, with the export-to-GDP ratios being higher for hydrocarbon exporters than for metal exporters.

Chart 5

FDI Is The Buckle In The Belt And Road Initiative

Notwithstanding the increase in China's importance as an export destination for the Central Asian countries, China has become a major source of foreign direct investment (FDI) in recent years. According to the American Enterprise Institute and Heritage Foundation, Central Asia has received over $21 billion in investments over the past seven years under the Chinese Belt and Road Initiative (BRI), mostly for infrastructure and energy projects (and $56 billion in total). Investments from China have become especially important in Tajikistan and Kyrgyzstan, where the stock of Chinese FDI now constitutes almost 20% of GDP (see chart 6).

Chart 6

However, the average size of China's investments has declined in recent years (see chart 7) for several reasons. First, several large-scale projects involving the construction of infrastructure for transport and energy supply have finished. Second, China has adopted a more cautious investment strategy, following comparable decreases in investments in other BRI regions, such as sub-Saharan Africa. Finally, certain Chinese projects have faced protests in some countries, Kyrgyzstan in particular. In 2020, for example, protests broke out in Kyrgyzstan's central Naryn region against a Chinese-funded logistics center.

Chart 7

Chinese Demand For Energy Is Set To Slow

How Central Asia's exports to China evolve in the coming years depends on two crucial trends: the rebalancing of China's economy from an investment-led to a consumption-led growth model, and the country's adoption of new climate goals (see "China's Climate Ambition Restrained By Supply Security," published April 20, 2021, on RatingsDirect for further details).

China's path to a consumption-led growth model should see private consumption overtake investment as a share of total GDP in the coming years (see chart 8). This will have two notable implications for the export dynamics between China and Central Asia. First, a slowdown in infrastructure and property investment would weigh on the demand for metals, since this is used in construction. Second, a consumption-led growth model is less energy-intensive, implying that growth in China's energy consumption may moderate, although it should remain positive.

Chart 8

A shift to a consumption-led from an investment-led growth model is notable among countries with higher levels of income. As income per capita rises, growth in energy consumption slows, with the exception of countries in the Gulf and those with cold climates (see chart 9). We expect China to follow suit, although, given the importance of energy-intensive industries for the Chinese economy, we expect growth in China's energy consumption to moderate more slowly than in other countries with comparable income levels.

Chart 9

The Chinese government's decarbonization initiatives also play an important role in the country's energy consumption, and the government is set to cut energy consumption per unit of GDP by 13.5% by 2025 (see S&P Global Platts' report "China Set To Cap Coal consumption, boost domestic oil & gas output in 2021," published April 26, 2021). Apart from that, any downturn in the property markets, and therefore in construction, will also affect China's demand for energy.

Exports To China Will Rise Less Under Consumption-Driven Growth

To determine the possible effect of a drop in China's investment-to-GDP ratio on bilateral trade flows, we used a gravity model of trade. We simulated a scenario where China's investment-to-GDP ratio declines by more than 10 percentage points, keeping all other macroeconomic factors constant (see Appendix for more details). This level of decline is similar to that in Korea or Japan, which transitioned from investment- to consumption-based economies in the 1980s and 1990s. In a "Korea" scenario (investment-to-GDP ratio drops to 31%), exports will rise less, with the gap between the baseline scenario (investment-growth model) and the Korea scenario being 10% on average. In a "Japan" scenario (ratio drops to 24%), the average gap becomes 15% (see chart 10). The rebalancing of the Chinese economy, as well as a likely slowdown in China's economic growth in the medium term, may therefore slow the growth of exports from Central Asia to China.

Chart 10

The Decarbonization Of The Chinese Economy Could Still Benefit Central Asian Gas Exporters

China's decarbonization strategy, announced in September 2020, sets an ambitious target of achieving carbon neutrality by 2060. To achieve this target, the Chinese government plans to increase the use of renewable sources of energy, as well as reduce its reliance on coal. More important for Central Asia's exporters is the plan's more widespread use of gas as an energy source, at least in the medium term, since it leaves a smaller carbon footprint than coal. Therefore, even though the pace of growth in China's energy consumption may moderate in the medium term, gas imports and production should continue to increase (see S&P Global Platts' report "Commodities 2021: China's natural gas demand set to hit new record," published Jan. 7, 2021). This should benefit countries with significant gas reserves and proximity to China, namely, Turkmenistan, Kazakhstan, and Uzbekistan, which have some of the largest gas reserves in the world (see chart 11).

Chart 11

This doesn't necessarily mean that countries that don't export gas will be left behind. Turkmenistan and Uzbekistan don't share a border with China, meaning that gas transit may go through Kyrgyzstan and Tajikistan. That said, high logistics costs remain an issue, even though spending to improve infrastructure has picked up significantly in these countries, according to the International Transport Forum. Cooperation between the countries is also crucial.

Another positive is the fact that China is expected to import more consumer goods, and therefore it could outsource some of its manufacturing to Kyrgyzstan and Tajikistan, given their lower labor costs and proximity to China. However, political instability in these countries could hold back the investments that outsourcing would require. A fourth industrial revolution in the form of job automation could also undermine the potential for outsourcing since it makes the difference in labor costs between countries less relevant.

All in all, Central Asia has benefited hugely from its integration with the global economy and establishment of economic relations with China. However, China's economic rebalancing and decarbonization strategy carry both risks and opportunities for Central Asia. The ability to adapt quickly to the changing world and cooperate with countries both inside and outside Central Asia will be crucial for the region in the decades to come.

Appendix: Estimating Potential Trade Flows Using The Gravity Model

The gravity model of trade is an econometric approach used to determine the size of trade flows between two countries by taking into consideration variables such as the distance between the countries, population, and GDP, and other macroeconomic factors like the investment-to-GDP ratio in the importing country. The relationships between the variables are estimated using regression analysis. We used the Poussin Pseudo-Maximum Likelihood technique as per Silva and Tenreyro (2006) to perform the regression analysis in this study and account for the zeros in the dataset. Our exact specification takes the following form, where i denotes an exporter, and j denotes an importer:

.

Apart from the classical set of variables (distance, population, and GDP), our model includes the GDP composition of the importing country, and the language ties, contiguity, colonial links, and regional trade agreements between the countries. We also controlled for year- and country-specific effects. As the model estimates the elasticities between trade flows and various macroeconomic factors, it is possible to model potential trade volumes under certain conditions. We used this method to derive the potential export volumes from Central Asia to China, as well as those in the "Korea" and "Japan" scenarios in chart 10.

Our dataset is based on data from the Centre d'Études Prospectives et d'Informations Internationales (CEPII), a French institute for research into international economics, and Penn World Tables. The dataset covers 87 countries and spans 1960 to 2019. All the exporting countries in our sample are commodity-dependent exporters. We consider a country to be commodity-dependent if more than 60% of its merchandise exports are commodities, in keeping with the United Nations Conference on Trade and Development's State of Commodity Dependence 2021 report. We included only commodity-dependent exporters (rather than the full of set of all world economies) to control for the unique composition of the exports from Central Asia.

Related Research

S&P Global Ratings

• China's Climate Ambition Restrained By Supply Security, April 20, 2021
• Energy Transition: Consumers Can Help Deliver A Carbon Neutral China, Dec. 10, 2020
• China Credit Spotlight: The Great Game And An Inescapable Slowdown, Aug. 29, 2019

S&P Global Platts

• China set to cap coal consumption, boost domestic oil & gas output in 2021, April 26, 2021
• Commodities 2021: China's natural gas demand set to hit new record, Jan. 7, 2021

External Research

• American Enterprise Institute and Heritage Foundation (2021), China Global Investment Tracker, October 2021, https://www.aei.org/china-global-investment-tracker/
• BP Statistical Review of World Energy (2021), October 2021, https://www.bp.com/en/global/corporate/energy-economics/statistical-review-of-world-energy.html
• Feenstra, R.C., Inklaar, R. and Timmer, M.P., (2015), "The Next Generation of the Penn World Table", American Economic Review, 105(10), 3150-3182
• Head, K. and T. Mayer, (2014), "Gravity Equations: Toolkit, Cookbook, Workhorse." Handbook of International Economics, Vol. 4, eds. Gopinath, Helpman, and Rogoff, Elsevier
• International Monetary Fund (2021), World Economic Outlook, October 2021, https://www.imf.org/en/Publications/WEO
• International Transport Forum (2019), "Enhancing Connectivity and Freight in Central Asia," International Transport Forum Policy Papers, No. 71, OECD Publishing, Paris
• Investment Map (2021), International Trade Center, October 2021, https://www.investmentmap.org/home
• Russian.news.cn (2017), October 2021, http://russian.news.cn/2017-01/19/c_135996502.htm
• Silva, S. and S. Tenreyro, (2006), "The Log of Gravity", The Review of Economics and Statistics, 2006, vol. 88, issue 4, 641-658
• UNCTAD (2021), "State of Commodity Dependence 2021," UNCTAD
• UNCTADstat (2021), October 2021, https://unctadstat.unctad.org/EN/
• Uzdaily (2020), "Issues of expanding investment activities of Chinese companies in the textile industry of Uzbekistan discussed", October 2021, http://www.uzdaily.com/en/post/54399