TURKMENISTAN 2008 INVESTMENT CLIMATE REPORT

UNCLAS SECTION 01 OF 06 ASHGABAT 000014

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TAGS: ECON EFIN OPIC KTDB USTR TX
SUBJECT: TURKMENISTAN 2008 INVESTMENT CLIMATE REPORT


1. (U) Text of Embassy Ashgabat's Investment Climate Statement for
2008 is as follows:

BEGIN TEXT OF PART I OF II:

OPENNESS TO FOREIGN INVESTMENT

Turkmenistan is a relatively large but sparsely inhabited country
(about five million) with abundant hydrocarbon resources. The
government regularly proclaims its wish to attract foreign
investment, but its state-control mechanisms and restrictive
currency-exchange system have created a difficult foreign-investment
climate. Historically, the most promising areas for investment are
in the oil and gas, agricultural and construction sectors. Even in
these areas, companies must conduct extensive due diligence. The
lack of established rule of law, inconsistent regulatory practices,
and unfamiliarity with international business norms are major
disincentives to foreign investment. Although President Gurbanguly
Berdimuhamedov has expressed his intent to improve investment
conditions, to date he has taken no specific related actions.

Turkmenistan's economy depends heavily on production of natural gas,
oil, petrochemicals and, to a lesser degree, cotton and textiles.
The country is the second largest gas producer in the former Soviet
Union. All other existing industrial production, with the exception
of food processing, needs substantial development. The country's
key industries are still state-owned. According to independent
estimates (European Bank of Reconstruction and Development EBRD
Transition Report 2007),the private-sector share in GDP in 2006 was
25%, mostly concentrated in retail trade, services and food
processing.

The top economic development priority of the Government of
Turkmenistan since independence in 1991 has been self-sustainability
in food supplies and an increase in import-substituting production
using hydrocarbon revenues. Other industries where the government
has been most receptive to foreign investment are the textile and
construction sectors, which all acutely need modern technology,
knowledge of international markets and experience in international
business practices. All investment proposals are screened for
compliance with these government priorities. The national program
entitled "Economic, Political and Cultural Development Strategy for
Turkmenistan to 2020" specifies government plans for the petroleum,
chemical, power generation, mining, metallurgy, textiles,
construction, agriculture, transportation, communication and other
industries. In October 2006, Turkmenistan adopted the Oil and Gas
Development Plan for 2007-2030.

Turkmenistan has a closed investment climate. Decisions to allow
foreign investment are politically driven; companies from "friendly"
countries are more successful in winning tenders and signing
contracts. The country has significantly reduced its foreign
borrowing, particularly from international donor organizations,
because of leadership fears that overseas loans may lead to
political dependency on foreign states. However, since
independence, Turkmenistan has accepted financing from IFIs for a
variety of projects. In this environment, where the government
selectively chooses its investment partners, a strong relationship
with the government is essential. Often, government officials
expect personal gain for allowing or helping foreign investors enter
the local market. One way to penetrate the market has been to work
through established foreign businessmen, who arrange deals through
their personal relationship with top leaders, or via high-ranking
foreign officials. Preliminary indications seem to demonstrate that
establishing a personal relationship with the new president will
remain the most direct -- and in some cases, the only -- way to gain
entry to Turkmenistan's market.

Incoming foreign investment is regulated by the Law on Foreign
Investment (last amended in 1993),the Law on Investments (last
amended in 1993) and the Law on Corporations of 1999, with respect
to start-up corporations, acquisitions, mergers and takeovers of

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corporations. Foreign-investment activities are affected by
appropriate bilateral or multilateral investment treaties, the Law
on Enterprises of 2000, the Law on Business Activities (last amended
in 1993),and the Land Code approved in 2004. Foreign investment in
the oil and gas sector is subject to the 1996 Petroleum Law (last
amended in December 2005). The Tax Code provides the legal
framework for the taxation of foreign investment. The 2000 Civil
Code defines what constitutes a legal entity in Turkmenistan, as
well as requirements for registration. Much foreign investment is
governed by project-specific presidential resolutions, which may
grant privileges not provided by the general legislation.

Legally, there are no limits on foreign ownership or control of
companies. In practice, the government has allowed fully-owned
foreign operations only in the oil sector and, in one case, in
cellular communications (MTS of Russia). There are various ways for
the government to discriminate against disfavored foreign as well as
domestic investors: excessive tax examinations, license extension
denial, and customs clearance and visa issuance obstacles. Starwood
Hotels and Resorts operated two Sheraton-franchise hotels in
Ashgabat, but left Turkmenistan in 2006 as a result of disagreements
over interpretation of its contract with the government.

In most cases, the government has insisted on maintaining a majority
interest in any joint venture (JV). Foreign investors have been
reluctant to enter JVs controlled by the government, as a result of
competing business cultures and conflicting management styles.
Foreign investors may only sell shares or divest with government
permission, although there is no specific legislation. Coca-Cola
Bottlers has been in Turkmenistan since the mid-1990s in a JV with
the government.

Government efforts since 1991 to privatize former state enterprises
have attracted little foreign investment. Privatization has been
limited to the service and trade sectors, with most industry still
in state hands. Out-dated technology, poor business structures, and
governmental obstacles make privatized firms unattractive as
outright purchases for foreign investors. To date, government
privatization efforts have also been counteracted by lingering
prejudice against the private sector. In cases where there is
income potential, the government has been quick to crowd out the
private sector as a competitor.

All land is government-owned. Neither domestic nor foreign entities
can receive long-term land-use rights for "non-agricultural"
purposes. Private citizens have land rights under specific
circumstances. However, these rights exclude the sale or mortgage
of land. Land rights can only be transferred through inheritance.
Foreign companies or individuals are permitted to lease land for
non-agricultural purposes, but only the president has the authority
to grant the lease.

The government has attempted to introduce an element of competition
for state contracts by announcing international tenders for some
projects. In many cases, Turkish companies have been hired to act
as advisors in the tender process. Typically, these projects are
politically motivated and/or economically unsound, and the tender
process is badly managed and often not transparent, timely,
well-prepared, or accessible. Following the president's
announcement of a potential project, interested foreign investors
and/or suppliers often contact the relevant government agency
directly in case the tender is not announced publicly. There is one
case of a U.S. company being told it was awarded a tender, investing
in initial project design, and then being informed the government
was considering other options. The tender was offered a second
time, and the contract was awarded to a new company at double the
U.S. company's tender price. Investors should always put
agreed-upon terms in writing and never act on verbal promises.

Turkmenistan signed a Trade and Investment Framework Agreement
(TIFA) with the United States, Kazakhstan, Tajikistan, Kyrgyzstan,
and Uzbekistan on June 1, 2004. The TIFA established a regional

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forum to discuss ways to improve investment climates and expand
trade within Central Asia. However, the Government of Turkmenistan
does not actively engage in regional efforts aimed at boosting
investment projects. Turkmenistan sells electricity to Afghanistan
at subsidized rates

Since independence in 1991, Turkmenistan has received an estimated
$2.86 billion in foreign direct investment (FDI) (EIU Turkmenistan
Country Report, October 2006). In October 2006, the Government
stated that Production Sharing Agreement (PSA) operators (Petronas,
Burren Energy, Maersk/Wintershall Consortium, Mitro International of
Austria/Turkmennebit Consortium) had invested $1.34 billion in their
local operations. The EBRD Transition Report Update (May 2006)
projected net FDI for 2006 to total $308 million.

CONVERSION AND TRANSFER POLICIES

The Government of Turkmenistan maintains tight control over the
country's main foreign-exchange flows. There are two de facto
exchange rates. The official rate has remained fixed at 5,200
manats per dollar since 1998; for the last three years the
unofficial rate has hovered around 24,000 manats per dollar. By
presidential decree, as of January 1, the "unofficial" exchange rate
can be no higher than 20,000 manats/dollar . In the latter part of
2006, benefiting from the steady flow of natural gas and oil income,
the government began to allow banks to convert manats from some
commercial entities at a near-unofficial rate of 22,800 manats per
dollar. Foreign bankers considered this newly-permitted
currency-exchange system to be a modest step towards overall
liberalization of the foreign exchange market. The Central Bank is
known to control the unofficial rate by releasing large quantities
of U.S. dollars into the unofficial (but legal) exchange market.

In November 2007, President Berdimuhamedov announced his intention
to unify the exchange rate by 2009. The Government of Turkmenistan
also plans to release new, redenominated currency at that time. In
preparation for exchange rate unification, Berdimuhamedov has stated
that Turkmenistan will seek advice from international financial
institutions.

Oil producers operate under the Petroleum Law and receive their
profit share in crude oil, which they ship by tankers to other
Caspian Sea littoral states or swap in Iran or Persian Gulf
countries. In many cases, investors in petrochemicals have
negotiated deals with the Government of Turkmenistan to recoup their
investment in the form of future petroleum products. Foreign
investors generating revenue in foreign currency, such as textile
factories, do not generally have problems with repatriating their
profits. However, some foreign companies receiving income in local
currency, such as Coca-Cola, seek indirect ways to convert local
currency to hard currency through the purchase of petroleum and
textile products in manat for resale on the world market.

Turkmenistan imports the vast majority of its industrial equipment
and consumer goods. The government's foreign-exchange reserves pay
for this industrial equipment and various investment projects. The
demand for hard currency in Turkmenistan's private retail sector
seems to be satisfied by the unofficial but legal exchange market
and the newly-introduced possibility to also buy dollars in banks at
the "near-unofficial" rate.
EXPROPRIATION AND COMPENSATION
Turkmenistan's legislation does not provide for private ownership of
land, and thus offers opportunities for the government to force
investors to vacate their land. Article 21 of the Investment Law
allows investors' property to be confiscated by a court decision.
Although there have been no reported expropriatory actions against
foreign investors in the last year, the Government of Turkmenistan
has a history of arbitrary expropriation of the property of local
businesses and individuals. Under the previous leadership, the
government often refused to pay any compensation, much less fair
market value, when exercising "the right of eminent domain." For
example, as part of a "city beautification" project to widen

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Ashgabat's streets, hundreds of homes and some local businesses were
destroyed. Homeowners were given short notice and little, if any,
compensation for loss of their dwellings. However, during a March
2007 Cabinet of Ministers meeting, President Berdimuhamedov stated
that residents of affected apartments or houses would be provided
with alternative housing before their homes are demolished. In
2007, neighbors who were promised housing six months after their
apartments were to be destroyed appealed to international
organizations in order to obtain new housing immediately, and were
given new apartments shortly thereafter.

DISPUTE SETTLEMENT

Most contracts negotiated with the government have an arbitration
clause. Embassy strongly advises U.S. companies to include an
arbitration clause with a venue outside Turkmenistan.

There have been several commercial disputes over the past few years
involving U.S. and other foreign investors or contractors in
Turkmenistan, though not all the disputes were filed with
arbitration courts. Turkmenistan's investment and commercial
disputes have three common themes: non-payment of debts,
non-delivery of goods or services, and contract renegotiations. The
government may claim the provider did not meet the terms of a
contract as justification for non-payment. Most disputes have
centered on the government's unwillingness to pay in hard currency
as contractually required. In cases where government entities have
not delivered goods or services, the government has often ignored
demands for delivery. Finally, a change in the leadership of a
government agency that signed the original contract often triggers a
government call to re-evaluate an entire contract, including profit
distribution, management responsibilities and payment schedules.

A western oil and gas company and Turkmenneft, the government-owned
oil company, have been in litigation since 1996. Under the auspices
of the International Chamber of Commerce, in 2001 the western
company was awarded of $495 million in damages. In spring 2006, the
U.S. Court of Appeals upheld the 2001 decision and bound the
Government of Turkmenistan to an arbitral award rendered by a
tribunal sitting in Houston, Texas, in favor of a foreign party
against State Concern Turkmenneft. In November 2006, the U.S.
Supreme Court denied Turkmenistan's petition for a writ of
certiorari. The award has not been paid.

Although Turkmenistan has adopted a number of laws designed to
regulate foreign investment, the laws have not been consistently or
effectively implemented. The concentration of power in the office
of the president has undermined the rule of commercial law.
Legislation is regularly made -- or overturned -- by presidential
decree. The Law on Foreign Investment, as amended in 1993, is the
primary legal instrument defining the principles of investment. The
law also provides for protection of foreign investors. The foreign
investor is defined in the law as an entity owning a minimum average
of 20% of a company's assets during a calendar year, unless the
Cabinet of Ministers waives the requirement.

The following is an ad hoc list of relevant legislation regarding
foreign investments:

-- All foreign and domestic companies and foreign investments must
be registered at the Ministry of Economy and Finance (MOEF).
--The Petroleum Law (Law on Hydrocarbon Resources) regulates
offshore and onshore petroleum operations in Turkmenistan, including
petroleum licensing, taxation, accounting and other rights and
obligations of state agencies and foreign partners. The Petroleum
Law supersedes all other legislation pertaining to petroleum
activities, including the Tax Code.
-- According to the Land Code, foreign companies or individuals are
permitted to lease land for non-agricultural purposes, but only the
president has the authority to grant the lease. Foreign companies
may own real estate property other than land.
-- Turkmenistan adopted a Bankruptcy Law in 1993.

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-- Other laws affecting foreign investors include the Law on
Investments (last amended in 1993),the Law on Corporations of 1999,
the Law on Enterprises of 2000, the Law on Business Activities (last
amended in 1993),the Civil Code enforced since 2000, and the Law on
Property of 1993.

The commercial-law enforcement system includes the Arbitration Court
of Turkmenistan (Arachy Kazyyet) which tries 13 categories of
disputes, both pre-contractual and post-contractual, including
taxation, legal foundations and bankruptcy issues. The court does
not interfere in enterprises' economic relations, but considers
disputes by request from either party involved. Appeals on
decisions of the Arbitration Court can be filed at the Arbitration
Committee of the Supreme Court of Turkmenistan.

Turkmenistan has not become a Party to the Convention on the
Settlement of Investment Disputes Between States and Nationals of
Other States (also known as the Washington Convention) or the New
York Convention of 1958 on the Recognition and Enforcement of
Foreign Arbitral Awards or any other internationally recognized
arbitration agreement.

PERFORMANCE REQUIREMENTS/INCENTIVES

Foreign investors are disadvantaged by higher tax rates than most
local companies. The Tax Code adopted in 2004 was amended three
times, in 2005, 2006 and 2007, but with most tax rates remaining
unchanged. The Value Added Tax is 15%, an income tax of 8% is
applied to JVs and an income tax of 20% to wholly-owned foreign
companies and state-owned enterprises. Dividends are taxed at 15%,
and the personal income tax is 10%. In 2005, the government of
Turkmenistan amended the tax code, giving more concessions to
domestic private companies. The Code exempted domestic private
companies from the VAT and property tax and reduced the income tax
from 8% to 2%. In August 2006, Turkmenistan increased its excise
tax on imported beer (50%) and wine (100%). Similar taxes on
domestically produced beer and hard liquor remain at previous rates:
10% and 15%-40% respectively.

In May 2007 Turkmenistan introduced a National Tourism Zone (NTZ) to
promote tourism development on the Caspian Sea coast. Tax and other
incentives are provided in the new legislation passed on October 1,
but only to those willing to invest in construction of hotels and
recreational facilities. The amendments to the Tax Code passed on
October 1 exempt construction and installation of tourist facilities
in the NTZ from the VAT. Various services of tourist facilities,
including catering and accommodation, are also VAT-exempt. Income
tax on accommodation and catering of tourist facilities will not be
levied for the first 15 years.

Equipment purchased by the investor as part of the registered
capital, other assets to be used in production, and personal
household effects of investors' employees are duty free.

Tax and investment incentives can be negotiated on a case-by-case
basis. The president has often issued special decrees granting
taxation exemptions and other privileges to specific investors while
recouping the initial investment.
Assets and property of foreign investors should be insured with the
State Insurance Company of Turkmenistan (Article 53 of the Petroleum
Law, Article 3 of Insurance Law). National accounting and financial
reporting requirements also apply to foreign investors. All
contractors operating in Turkmenistan for a period of at least 183
days a year must register at the Main State Tax Service. There is a
general requirement for foreign investors that 70% of the company's
personnel be local. The government can make exceptions for foreign
construction companies executing large-scale turnkey projects.
Turkmenistan requires that all export and import contracts and
investment projects be registered at the State Commodity and Raw
Materials Exchange (SCRME) and the Ministry of Economy and Finance.
The procedure applies not only to the contracts signed at the SCRME,
but also to contracts signed between third parties. The SCRME is

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government-owned and is the only exchange in the country. The
contract registration procedure includes an assessment of "price
justification." All import contracts must be registered before
goods are delivered to Turkmenistan.

The government mostly favors long-term investment projects that do
not require regular hard-currency purchases of raw materials from
foreign markets. Textile factories operated by Turkish companies
using domestic resources and labor serve as model investment
projects supported by the government. These companies encounter
relatively few currency conversion problems and enjoy tax holidays.
Otherwise, there are no set requirements for local sourcing or
exporting specific percentages of output.

Production Sharing Agreement (PSA) holders are mostly regulated by
the Petroleum Law. They are subject to a 20% income tax and
royalties ranging from 1% to 15%, depending on the level of
production. The social welfare tax, 20% of the total local staff
payroll, is also payable by all foreign investors and their
subcontractors. PSA holders' employees and their subcontractors pay
a personal income tax of 10%. Under the Petroleum Law, PSA
concessions have been made to six foreign energy companies: three
offshore and three onshore concessions for 20-25 years. Five of the
existing concessions are in the oil sector and one in the gas
sector.

Subcontractors of PSA holders can bring their equipment into the
country only for a duration of a valid contract. There is no
appropriate legislation that regulates operations of oil and gas
subcontractors

Currently, Turkmenistan lists 94 import and nine export goods and
materials subject to customs duties. Goods and materials not on the
lists are subject to a 5% customs duty payment. In regard to
exports, customs maintains a list of goods subject to customs duty
payment. Export of fertilizers, non-ferrous metals, their alloys,
and products made of non-ferrous metals is prohibited. State
enterprises often receive preferential treatment; for example, wool
carpets produced at state factories are exempt from customs duties.
In contrast, private carpet producers have to pay 100% customs
duties for exporting carpets.

Foreign investors are required to adhere to the sanitary and
environmental standards of Turkmenistan. Foreign investors'
products should be of equal or higher quality than prescribed by the
national standards.

Turkmenistan, while not a member of the World Trade Organization
(WTO),has enacted a number of laws in key areas relevant to the
WTO: investment, banking, intellectual property rights, customs,
and privatization. However, the legislation is not enforced
uniformly. Turkmenistan is not a signatory to and is not in
compliance with the Agreement on Trade-Related Investment Measures
(TRIMS).

The State Service for Registration of Foreign Citizens was created
in 2003 with the specific aim of controlling access to the country
and movement of foreign citizens within Turkmenistan. All visitors
are required to register upon entry, and travel to most border areas
requires a special permit. Inviting foreigners often is
problematic, because authorities can and do deny entry visas without
explanation. With these travel strictures, foreign investors trying
to enter Turkmenistan for the first time have difficulty obtaining
entry visas unless invited by the government. Even established
investors continue to complain about bureaucratic procedures and
delays in this context.
END TEXT OF PART I OF II.
HOAGLAND