Part 1 of 2, 2008 Investment Climate Statement for

UNCLAS TASHKENT 000101

SIPDIS

SIPDIS

DEPT FOR SCA/CEN, AND EB/IFD/OIA
DEPT PASS TO USTR

E.O. 12958: N/A
TAGS: ECON EFIN EINV ELAB ETRD KTDB PGOV OPIC USTR UZ
SUBJECT: Part 1 of 2, 2008 Investment Climate Statement for
Uzbekistan

REF: 07 STATE 158802

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Openness to Foreign Investment
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1. With an estimated population of 27.3 million, Uzbekistan has the
largest population in Central Asia. Rich natural resources such as
gold, gas, and cotton offer potentially attractive opportunities for
investors. Uzbekistan is the world's fourth largest cotton producer
and second largest cotton exporter after the United States.
Uzbekistan has the potential to be a regional economic powerhouse,
but the government of Uzbekistan ("the government") has yet to
create the necessary conditions to attract needed foreign
investment. Currency convertibility is cited by foreign firms as
the single greatest obstacle to normal investment operations.


2. The declared policy of the government is to attract foreign
investment. Existing legislation on its face grants foreign direct
investors a host of incentives on a case-by-case basis, including
tax holidays, duty-free import of capital goods, and protection
against expropriation. However, the requirements for obtaining
these benefits are ambiguous, the processes and procedures are
cumbersome, and the regulatory environment is capricious. While
such conditions provide opportunities for some companies to turn
special decrees and privileges to their advantage, the lack of
predictability deters many potential investors.


3. According to Uzbek law, the state must guarantee and protect the
rights of foreign investors within the country. Primary legislation
that guarantees foreign investment includes the following decrees:
"On Foreign Investments," "On Guarantees and Measures of Protection
of Foreign Investor's Rights," "On Guarantees of the Freedoms of
Entrepreneurial Activity," and "On Production Sharing Agreements."



4. Enterprises with foreign investments enjoy tax concessions and
preferences, such as a reduced profit tax rate, grace periods, and
exemption from customs duties on the property imported by foreign
investors for their own production and personal needs. However, the
government has in some cases negated this benefit by reclassifying
foreign investments as joint ventures or local investments. Foreign
investors also are shielded for ten years from legislative changes
that adversely affect existing investments. In July 2006, however,
the government rescinded all existing, indefinite tax breaks for
foreign companies, other than those with product-sharing agreements,
such as oil and gas companies. This adversely affected a number of
foreign businesses, mostly American and European, and some closed
operations. The 2006 legislation, which was retroactive, did not
allow investors to claim damages.


5. In principle, the judicial system upholds the sanctity of
contracts. However, the judiciary is not independent and has
favored state-owned or government-affiliated entities in commercial
disputes. Foreign investors often retain independent local counsel.



6. The government plans to retain controlling shares of some key
industries, including oil and gas, aviation and mining. The
government limits access to the raw cotton market, thereby
exercising effective control of investments and capital flows. The
government controls all silk sold in the country, and this dampens
foreign investment in the textile and rug-weaving industries. This
is not an exhaustive list. The government's role in key industries
can have discriminatory effects on foreign investors. The
government has announced plans to privatize some mid-sized and large
state-owned companies but has not yet done so. Moreover, a variety
of challenges exists, including unrealistic valuations and the
choice of which assets to retain.


7. In the banking and insurance sectors, foreign ownership is
restricted. In banking, foreign investors are prohibited from
legally operating except as joint venture partners with Uzbek firms,

and foreign ownership of banks is limited to 50 percent. Banking
and insurance firms with foreign participation are required to
establish a charter capitalization fund of 5 million Euros, whereas
the government determines the required size of the charter funds for
Uzbek firms on a case-by-case basis. (See also paragraph 17).


8. An "enterprise with foreign investment" and an "enterprise with
foreign capital" are treated differently in Uzbekistan. Foreign
investors act as shareholders in both cases; however, an enterprise
with foreign investment has a special status and additional
requirements, including:

-- foreign investments must comprise at least 30 percent of shares
of the charter fund of the enterprise;

-- foreign investors, as a legal entity, must be among the
participants in the enterprise; and

-- the minimum amount of charter capital must not be less than USD
150,000 (for enterprises established within the Republic of
Karakalpakistan and Khorezm province, the amount is USD 75,000).


9. Enterprises that meet the above requirements can be registered as
"enterprises with foreign investment." Enterprises that do not meet
the above requirements are subject to state registration at the
offices of regional governors (hokimiyats) as ordinary enterprises.


10. If the charter fund of an enterprise with foreign investment
comprises USD 20 million or more, a special government resolution is
needed to register the enterprise. Frequently even smaller
investments require permission from government authorities. The
Uzbek government requires screening of foreign investment in sectors
of the economy that it determines are strategic, including mining,
cotton processing, oil and gas refining, and transportation. The
government does not have a standard and transparent screening
mechanism, and the legislation is designed to protect domestic
industries and limit competition from abroad. In some instances,
screening has been used by the government to limit investment in
certain industries and by certain countries.


11. The following sectors are relatively more open to foreign direct
investment (FDI): oil & gas exploration, extraction and processing;
power (transportation and distribution, renewable energy); machine
building (automotive, agricultural, railroad trains and cars,
aerospace, etc.); and tourism infrastructure. However, the
government closely scrutinizes investments, particularly those
deemed to involve strategic national interests.


12. According to legislation, foreign investors and investments
receive treatment equal to that afforded local investors.


13. Uzbekistan subscribes in principle to policies of institutional
and economic reform, such as restructuring and privatization, in
order to attract more foreign investment. However, implementation
has been limited. A 2007 decree on privatization is promising, but
implementation has not begun. The government to date has been
unwilling to sell controlling interests in enterprises, and often
has demanded prices far in excess of what investors would be willing
to pay. Enterprises developed under the previous Soviet economic
system need significant restructuring before they can be
successfully privatized. In general, the tender process for
privatization is transparent only at the initial stage. The
government attracts international financial consultants for
privatization of large enterprises. Only after the evaluation of an
enterprise is completed are foreign investors invited to participate
in the process. Many investors note a significant lack of
transparency at the final stage of the bidding process, when the
government begins conducting direct negotiations with the bidders
before announcing the results of the tender. In some cases, the
government lobbies foreign mailbox companies associated with
influential Uzbek families. While these companies have a foreign
address, their ties to the foreign country are tenuous.


14. There is no official discrimination policy against foreign
investors at the time of the initial investment or after the
investment is made. Certain incentives designated by presidential
decree are granted on a case-by-case basis and are often disputed
during the investment period. This issue is particularly acute in
regards to tax incentives and registration requirements. Recently,
several foreign investors noted conflicts between new legislation
and a Presidential Decree on tax holiday time limits. Presidential
decrees are in practice easily overturned, and foreign companies
have recently been detrimentally affected by the practice.


15. Foreign and local investors both suffer from government
interference in investments, and bureaucratic obstacles consume
significant time and resources. The current system of taxation is
complicated and ambiguous. The taxation legislation makes offset of
current losses impossible: a company that does not show a concrete
profit for six months is considered bankrupt. The legislation also
sets strict limits on deductions for marketing, communication and
training expenses, and thus greatly inflates taxable income when
compared with legislation in other countries. Corruption and rent
seeking are endemic. A new Tax Code has been approved and entered
into force January 1, 2008. Despite some decrease in tax rates and
the allowance of deductions for certain expenses, the new code does
not significantly alter the existing situation and does not address
the issue of official corruption.


16. Foreign investment, participation, or control in private firms
in the media sector is prohibited. According to the "Law on Mass
Media" adopted on December 26, 1997, and updated in 2005, only Uzbek
nationals can own a mass media enterprise. Joint ventures cannot
apply for a mass media license or own/establish a mass media
enterprise if the shares of the foreign investors exceed 30 percent.



17. Foreign ownership of private firms is in principle unrestricted,
with the significant exception of firms in the media, tourism,
banking and insurance sectors (see paragraphs 7, 16 and 32).
However, the government often exerts influence over the operations
of companies, even those where foreign investors own over 50
percent. In many privatized enterprises, the government retains a
minority share of approximately 25 percent, and workers own another
25 percent, thus limiting effective control by outside investors.


18. Uzbekistan has all the ingredients needed to become a regional
economic powerhouse: a dynamic, literate, and entrepreneurial
population; a central location at the crossroads of Central Asia;
relatively good infrastructure; rich mineral resources; and a large
potential consumer market. The lack of macroeconomic and structural
reforms has exacerbated bureaucratic inefficiencies and contributed
to widespread corruption. Businesses and investors suffer from a
multitude of problems caused by government policies. Instead of
instituting structural reforms immediately after independence in
1991 and weathering the resulting economic hardships, as some other
post-Soviet countries did, the government chose to avoid taking
painful reform measures and now faces a rapidly declining planned
economy. Official statistics expect GDP growth rate to be 9.8% in

2007. This growth is mostly due to the natural gas and construction
sectors, as well as remittances from large number of Uzbeks working
abroad. The construction sector is contracting, as Kazakh investors
in Uzbekistan react to the credit crunch in their own country.
Currency restrictions through the banking system hamper business and
economic development, as do the government's restrictive trade
policies. The government's manipulation and interference in the
private sector leave companies unable to properly project profits
and future capital purchases.

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Conversion and Transfer Policies
--------------


19. Uzbekistan introduced currency convertibility in October 2003,
but in practice access to foreign currency is limited. Two legal
exchange rates exist: the commercial (wire-transfer) rate and the

exchange booth rate. All citizens have legal access to the exchange
booth rate. Limitations to foreign exchange resulted in 2007 in
average lag times of four months for current account convertibility
for imports and slightly less for raw materials related to
manufacturing. As of December 2007, the black market rate of 1,340
soum per U.S. dollar exceeded the official exchange booth rate of
1,288 by roughly four percent. Although the government has
committed to the provisions of the International Monetary Fund's
Article VIII regarding currency convertibility for current account
operations, in practice multiple informal restrictions remain in
place. All legal entities must obtain permission from the Central
Bank to access foreign currency, and applicants must expend
significant time to navigate the bureaucracy. The government
reportedly issues banks confidential instructions detailing which
orders are to be filled.


20. The majority of foreign investors, regardless of nationality,
report frequent difficulty obtaining sufficient foreign currency for
operational requirements. Investors also experience delays of one
to six months when remitting profits, and during the interim the
amount to be remitted is held by the Central Bank. These delays are
at least in part a result of the government's tight fiscal and
monetary policies - the government runs a strict import subsidies
regime to control foreign trade and prevent capital outflow.
However, the policy also presents the potential of co-mingling or
misuse of investor funds.


21. No legal, private, parallel market exists in Uzbekistan for
investors to remit funds. However, private money transfer
businesses are numerous and have few problems receiving foreign
remittances. The government has phased out its previous system of
import contract registration and replaced it with a regime of high
tariffs and border closings in order to further promote a policy of
import substitution. Due to border closings, foreign investors
often experience delays in receiving necessary production inputs.

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Expropriation and Compensation
--------------


22. The government may seize foreign investor assets for violation
of local legislation, breach of contract, failure to complete, as
well as for arbitrary reasons such as reevaluation of assets, site
or development programs, etc. Although the government can legally
seize property with compensation at fair market value, it has
expropriated property of joint ventures (with foreign investment
partners) at lower than fair market value. The government has also
inadequately compensated local businesses and individuals for seized
property. Agricultural enterprises are particularly vulnerable to
expropriation of land.


23. Recent changes in tax legislation, especially regarding tax
holidays, have caused financial difficulties for existing foreign
investors. Though this has not been construed as an attempt to
expropriate investor holdings, it is a matter of concern.


24. Large, lucrative foreign businesses are more at risk for
expropriation or similar action than others. In 2006, the
government targeted the two largest U.S. joint-ventures and
attempted to push them out of the country and expropriate their
assets. These two cases were eventually resolved, one through a
negotiated settlement and the other through arbitration. In both
cases, the U.S. partners relinquished their shares and left
Uzbekistan. The U.S. Embassy is aware of expropriation cases
involving non-U.S. companies, in the trading sector, food
processing, furniture manufacturing, and gaming businesses.

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Dispute Settlement
--------------


25. Uzbekistan does not have a uniform, well-defined method of
settling disputes or a legal system that fairly and effectively

enforces property and contractual rights. Government officials
inconsistently interpret laws and presidential decrees, which often
conflict with each other. Government interference in the court
system is common, as are accusations of corruption.


26. Investors have no reasonable expectation that the government
will honor an international arbitration verdict in favor of the
foreign plaintiff. Contractual provisions for international
arbitration are insufficient. If international arbitration is
permitted, the awards can be challenged in domestic courts. The
Ministry of Justice is responsible for the resolution of all
international commercial issues. Its power is limited and
frequently co-opted by more influential powers within the
government. A number of foreign companies have not received full
payment, even after being awarded a judgment in international
arbitration. Others have pursued a claim and won in the court
system, only to have the government not enforce the ruling. There
are several cases, however, in which international arbitration
awards have been successfully enforced.


27. Most disputes involve nonpayment or delayed payment for goods or
services by state entities. The State Tax Committee may sequester
funds from a company account before the court reviews the arguments
of the company in the dispute. The greatest number of U.S. investor
dispute cases have occurred in the following sectors: trading, food
processing, manufacturing, telecommunications, defense, energy,
gaming, and tourism. The only non-payment pattern the U.S. Embassy
has noted is in delivering products to the agro-chemical sector.
Disputes with joint venture partners, whether state-owned or
private, are also common. These disputes reflect a pattern of U.S.
investors relying too heavily on local partners and not thoroughly
vetting them before developing the joint venture partnership. The
local partners frequently cannot stand up to heavy government
pressure or are simply corrupt.


28. Uzbekistan is a member of the International Center for the
Settlement of Investment Disputes and a signatory to the 1958 United
Nations Convention on the Recognition and Enforcement of Foreign
Arbitral Awards (The "New York" Convention). However, numerous
companies have reported that the local courts, including the
Tashkent Economic Court and the Supreme Court, have failed to
enforce international judgments against Uzbek companies,
particularly state-owned enterprises.

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Performance Requirements/Incentives
--------------


29. Uzbekistan has not yet notified the WTO on inconsistencies with
Trade-Related Investment Measures (TRIMS) requirements. However, in
reply to WTO questions and at the request of a WTO member,
Uzbekistan described its "localization" program, a provision of
Resolution No. 18 of the Cabinet of Ministers issued 14 January
2004, that provides "Exemption from profit tax, single tax (for
entities subject to the simplified system of taxation) for a
percentage of products manufactured under localization projects".
Certain provisions of Resolution No. 18 violate the WTO TRIMS
agreement, namely that local businesses must use products of
domestic origin in manufacturing to receive advantages under the
localization program. This allegedly violates the WTO TRIM Annex
1(a).


30. According to Uzbek legislation, requirements to use domestic
products in manufacturing are to be applied uniformly. In practice,
this is not always the case. For example, the government has
granted some companies the advantages and incentives afforded under
the localization program, even though they do not use local
materials in production or assembly.


31. Customs payment exemptions envisaged under Resolution No. 18 are
not in conflict with Paragraphs 1 and 2 of Article III of GATT,
because this incentive is afforded to imported goods not produced in
Uzbekistan. Thus, there is no official import discrimination. In

certain situations conditions are actually more favorable for
foreign investors, as is the case with the services sector
specifically relating to freight forwarders: foreign freight
forwarders are exempt from VAT, while local companies are not.


32. While there are no set pre-conditions for investing, companies
must invest USD 150,000 in charter capital to qualify for certain
incentives. In addition, a foreign investor must invest at least 30
percent in a business for the company to be legally considered a
company with foreign investments. Also, as noted above, companies
must purchase products from local sources to qualify for the
localization program. This requirement applies to both foreign and
local investors; therefore, there is no national treatment problem
under Article III GATT '94. While there are no requirements that
foreign equity be reduced over time, certain restrictions regulate
foreign investments in the banking sector, where the foreign share
cannot exceed 50 percent, and in the tourism sector, where it cannot
exceed 49 percent.


33. Any sector that is not a priority industry for the Uzbek
government should expect to have more difficulty importing capital
and consumer products than a priority industry. Requirements
affecting these industries are likely considered restricted
information by the government and not applied uniformly.


34. Permission is not officially required to invest, though
preference is unofficially given to non-western firms and those that
are closest to the decision-makers. There are incentives to attract
foreign investments to less developed locations (mostly rural),but
there are no requirements. In the banking sector, branches are not
recognized as legal entities and therefore cannot provide banking
services that utilize the capital of the parent company.
Substitution for imports is covered under a localization program,
discussed in paragraphs 29 and 30. Host country employees are
required in some positions in banking and auditing companies: the
chief accountant should be an Uzbek national, as should either the
CEO or one member of the Board of Directors. In the tourism sector,
only Uzbek nationals can be tour guides. There are no requirements
for using only local sources of financing.


35. The government intends to eliminate requirements that are in
violation of certain WTO agreement provisions (such as TRIMS, the
Agreement on Subsidies and Countervailing Measures, and the General
Agreement on Tariffs and Trade) by the time Uzbekistan accedes to
the WTO. In October 2005, the government presented its offer on
goods and services to a WTO working group in Geneva. There are no
regulatory requirements for foreign investors to disclose
proprietary information. General legislation, such as the Civil
Code (Chapter 64) and "Law on Monopolistic Activity" (Article 8),
provide for general principles for the protection of commercial and
trade secrets. Participation in R&D is not regulated legislatively;
therefore, there are no government restrictions.


36. Uzbekistan offers two types of non-tourist visas: a temporary
business representative visa and a working visa. To apply, American
citizens must submit documents regarding the company/ business they
are affiliated with to an Uzbek Embassy or Consulate. Currently
almost all applicants experience delays or other problems in
obtaining Uzbek visas. Many non-resident, private American citizens
continued to receive visas limited to one month. Foreigners working
in Uzbekistan must register with the Ministry of Labor.


37. There are non-tariff barriers, such as discriminatory excise tax
rates for certain imported goods. Some goods are banned for export,
including grain and sugar. Import of ethyl spirit is prohibited.

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Right to Private Ownership and Establishment
--------------


38. Uzbekistan's laws and decrees guarantee the right of foreign and
domestic private entities to establish and own business enterprises
and to engage in most forms of remunerative activity. The state

reserves for itself the export of gold. Cotton and gold exports
generate most of Uzbekistan's foreign exchange earnings. The
government announced in a 2002 decree that it planned to scale back
its monopoly of the cotton export trade and allow producers to sell
50 percent directly to buyers. To date, however, this change has
not occurred. Foreign companies have entered the cotton and gold
production sectors, specifically grading, treatment, and marketing
of cottonseed, and mining and refining of gold. Some U.S. companies
have reported experiencing problems in the cottonseed and gold
refining businesses.


39. Theoretically, private enterprises may freely establish,
acquire, and dispose of equity interests in business enterprises. In
practice, however, it can be difficult to do this, as securities
markets are undeveloped.


40. Businesses face more than the usual amount of bureaucratic
hurdles if they compete with the government or a
government-controlled firm in certain sectors, such as minerals.

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Protection of Property Rights
--------------


41. Uzbekistan's laws governing the acquisition and disposition of
property pose relatively few problems for foreign investors, and are
similar to laws in other CIS countries. Foreign entities may own
buildings, but not land. The concept of property ownership exists
and is respected by local and central authorities, as long as the
government is not interested in owning that property. If the
government or a well-connected entity decides it wants to own a
piece of property, the original owner of the seized property should
not expect to receive remuneration at market value. Each district
Hokimiyat has a department responsible for management of commercial
real estate and controls all activities relating to the sale and
purchase of commercial real estate, from paperwork to asset
valuations.


42. Uzbekistan has actively voiced its interest in joining the WTO
but is only in the early stages of implementation of the appropriate
agreements, including TRIPS. In 2004, Uzbekistan submitted
documentation to become a party to the Berne Convention. In 2006,
the Uzbek Parliament adopted all but one component of the Berne
Convention: Article 18, regarding protecting pre-existing works.
This year the government amended its Civil Code to match the IPR
laws previously adopted. Presently, Uzbekistan is a consumer, but
not a significant producer, of pirated material. On the streets,
pirated audio and videotapes and compact disks are sold freely.

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Transparency of the Regulatory System
--------------


43. Ambiguous rules, legislation, and presidential decrees on
foreign investor rights are often contradictory. On many occasions,
local officials have interpreted laws in a manner that is
detrimental to individual private investors and the business
community at large. U.S. companies have complained that Uzbek laws
are not interpreted or applied consistently. In addition, the
government occasionally issues secret decrees or instructions that
entities are required to comply with, despite having no knowledge of
the order. Companies are particularly concerned with the consistent
and fair application of the "Law on Foreign Investment," which
outlines specific protections for foreign investors. Because of the
prohibitive tax code and regulatory environment, foreign investors
often seek tax incentives and relief from certain regulatory
requirements through Cabinet of Ministers decrees, which are
approved directly by the President. These, however, are easily
revocable.


44. The new Tax Code (see paragraph 15),like the old code, lacks
important provisions found in most developed countries. For
example, it does not allow credit for VAT on capital imports,

including plant, machinery, and buildings. This puts firms
operating in Uzbekistan at a competitive disadvantage. The tax code
makes no provisions on double taxation, and earnings of
foreign-owned enterprises are therefore susceptible to double
taxation. A double taxation treaty negotiated with the U.S. in 1994
has been ratified by Uzbekistan but not by the U.S. The law on
labor unions says that labor union fees are voluntary, but in
practice commercial courts interpret these payments as compulsory
and impose penalties on non-payers. The amount of money involved is
not large, but the issue may be of concern to foreign companies with
union policies and concerns. Strict rules on wages severely
discriminate against foreign companies who follow the rules, whereas
local firms often evade the laws by creating false employees.


45. Bureaucratic procedures, in particular financial reporting, are
considered time-consuming and counterproductive. Government-owned
banks, ministries, and agencies interfere in business operations and
in some cases make efficient operations almost impossible.
Documents required for licensing, registration and other permits are
often amended without notice, which creates an opportunity for
rent-seeking. As a result, documents are frequently rejected the
first time they are submitted on the grounds of some technicality.


46. The government holds a monopoly on regulatory processes.
However, influential actors in the "shadow economy" can create
problems for foreign investors in certain sectors, such as
telecommunications, real estate, mining, etc., by encouraging
authorities to pressure foreign competitors.


47. Publishing drafts of laws and regulations for public comment is
uncommon in Uzbekistan. Regulatory bodies often introduce changes
and amendments to the commercial legislation without notification,
which causes many disputes and misunderstandings, even among state
institutions. In a few cases where legislation will be highly
scrutinized by the private sector, certain well-placed foreign
investors have had the opportunity to review and comment on upcoming
legislation. However, these instances are extremely rare. There is
often a considerable delay between the passing of a law and its full
release for public consumption. The government has been discussing
the creation of a foreign investor council, which would provide an
excellent opportunity to review draft laws on commercial issues.
The Uzbekistan Chamber of Commerce and Industry has taken the lead
in organizing discussions for investors and business people on
issues of particular note as part of a larger forum.


48. Few of the local legal, regulatory, and accounting systems are
transparent and consistent with international norms. For instance,
local accounting standards and practice in some respects contradict
internationally accepted standards. Although international advisors
are working to develop the sector and train accountants, local
practice is still document and tax driven with an underdeveloped
concept of accruals. As a result, financial reporting seldom
accurately represents the financial position of Uzbek companies with
foreign investments.
NORLAND