Part 2 of 2, 2008 Investment Climate Statement for

UNCLAS TASHKENT 000102 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 2 of 2, 2008 Investment Climate Statement for Uzbekistan REF: 07 STATE 158802 Part 1 contained paragraphs 1-48. -------------- -------------- Efficient Capital Markets and Portfolio Investment -------------- -------------- ¶49. Although Uzbekistan has made some progress in financial sector reform, it is far from having an efficient market-oriented banking system and well-functioning capital markets. Financial sector reform has focused on creating an adequate legal and regulatory framework for financial intermediation and developing the sector's technical and institutional capacity. The result on paper is a developed legal foundation, stronger regulation and banking supervision, an internationally accepted set of accounting standards, an electronic payment system, and the creation of the Tashkent Stock Exchange (TSE) and National Depository. However, in many cases, adoption of legislation has not led to implementation. For instance, international accounting standards were adopted by banks in 1997. Many of these standards were not implemented because they do not comply with the Uzbek Tax Code. On the other hand, some government departments have implemented international accounting standards, but have not updated their systems on a timely basis. ¶50. The TSE, although in operation for several years, still hosts an extremely low volume of equity and secondary market transactions. The State Property Committee (GKI) decides who can buy and sell shares and at what prices, as the government is involved in the majority of local joint-stock companies. It is often impossible to locate accurate financial reports for the local companies traded on the TSE. Under a World Bank project, 25 percent of the shares in many firms have been sold to Privatization Investment Funds (PIFs), but there is very little secondary trading in those shares. Generally, the PIFs have not been able to exercise influence over corporate governance. ¶51. The introduction of a computerized payment system has substantially reduced inter-bank clearing and settlement times, which are now conducted almost in real time. This has eliminated costly floats of money and payment uncertainties, which were commonplace in the early years of independence. Consequently, banks are able to make timely monetary payments and better manage their liquidity. ¶52. Nonetheless, Uzbekistan's financial sector is still dominated by archaic banking rules and underdeveloped capital markets. The banking system is in turn dominated by large state-owned banks and marked by a lack of openness and competition, the presence of non-performing loans, and a relatively high degree of cross-ownership. Furthermore, the banking system remains the primary conduit for the government's directed credits to state-owned enterprises at negative real interest rates. The large portfolio of such credits poses a serious threat to the soundness of the banking system given the financial distress and un-profitability of most of these enterprises. Unofficial figures from reliable independent consultants estimated that in 2001, 60 to 70 percent of bank loans were non-performing. However, due to stricter control by authorities and a drop in the rate of loans issued, the percentage of non-performing loans in 2007 was probably closer to 25 percent. ¶53. In discussions with the IMF, the authorities argue that in the absence of a developed inter-bank market, it is too early to switch to a market-based system of money and credit management. Instead, the Central Bank of Uzbekistan intends to allocate credit through a system of competitive credit auctions as an interim measure. Foreign investors, therefore, have access to local credit, although the terms and interest rates do not make it a competitive or realistic source of additional funds. The underdeveloped financial system, coupled with the rent-seeking found in the government sector, makes finding reliable credit terms very challenging. ¶54. The micro-credit sector has been the focus of attention by the government, NGOs, and international banks. In 2006 the Uzbek government created its own bank, the Microcredit Bank; however, a few international banks speculate that the funds will not reach the intended recipients, but instead will be appropriated by the well-connected elite. A number of U.S.-based NGOs have been active in the past in supplying micro-credit; however these organizations have suspended their activities because the government has not issued implementing regulations to the new micro-credit law. The government forced several of these organizations to leave Uzbekistan in 2006 and effectively closed the operations of others through ¶2007. The EBRD, the IFC, and other international donors continue to explore possibilities for opening a micro-credit lending bank to help meet untapped credit needs. ¶55. The largest bank in the country is the state-owned National Bank for Foreign Economic Activity of Uzbekistan (NBU). NBU controls most of the commercial bank loan portfolio and 66 percent of Uzbekistan's foreign-exchange business. The government has reduced the number of state-owned banks in recent years (in part due to bank insolvency),although instead of releasing these assets for private-sector use, it transferred assets to a smaller number of state-owned banks, mainly Asaka Bank and NBU. According to NBU's last publicly-available report, the bank's capital totaled USD 485 million in 2005. ¶56. Uzbekistan's banking system continues to play an anomalous role in the collection and enforcement of taxes. Specifically, banks not only make tax payments at the request of their clients, but also help tax authorities enforce tax legislation. If a tax inspector perceives that a particular firm is not paying taxes in a timely manner, it orders the firm's bank to block its client's account. This arrangement applies to all businesses, including joint ventures. In a number of cases, tax inspectorates froze bank accounts of joint ventures, accusing them of tax evasion. A new anti-money laundering law came into force in 2006, obliging banks to report all financial transactions exceeding a certain threshold. This law was rescinded in 2007 due to an overburdening of the system, according to the government. Additionally, concerns existed that the law had been misused to gather financial information on banks' clients. ¶57. Another major source of irritation for firms operating in Uzbekistan is restricted access to cash. All inter-firm transactions must be conducted by bank transfer. Cash withdrawals by legal entities are only permitted for payment of wages and travel expenses. Cash receipts must be deposited on the same day they are received. A March 24, 2000 decree improved this situation somewhat by allowing individual entrepreneurs, some small enterprises, and joint ventures with foreign capital of $150,000 or more to withdraw cash from their bank accounts up to the amount deposited within the previous ninety days. However, in June 2001, the government issued a new decree instructing local administrations, commercial banks, and tax authorities to tighten control of cash circulation. The decree stiffened penalties for firms that fail to deposit their cash receipts in banks. Pervasive restrictions on cash withdrawals have resulted in many small enterprises conducting the bulk of their operations in cash, illegally. Any liberalization of restrictions on access to cash is likely to be gradual. The situation is aggravated by the fact that the largest denomination bill is 1,000 soum (less than 77 U.S. cents),turning transactions of any significant value into logistical undertakings. -------------- Political Violence -------------- ¶58. In May 2005, armed militants stormed a prison in Andijon, released its prisoners, and then took control of the regional administration and other government buildings in Andijon Province. Fighting broke out between government forces and the militants, and reports indicated that several hundred civilians died in the ensuing violence. While there were no reports of U.S. citizens affected by these events, U.S. citizens and other foreigners in Uzbekistan frequently have experienced harassment from authorities and local residents since the 2005 violence. ¶59. The State Department has issued several public notices specifically about the security situation in Uzbekistan, and all American citizens intending to invest in Uzbekistan should review the most current security information available via the State Department web site. Terrorists do not distinguish between official and civilian targets. Because of increased security at official U.S. facilities, terrorists may prefer softer civilian targets such as residential areas, clubs, restaurants, places of worship, hotels, schools, outdoor recreation events, and aircraft. The al-Qa'ida linked "Islamic Jihad Group" claimed credit for the suicide bomb attack against the U.S. Embassy in July 2004. This group also claimed credit for terrorist attacks in late March and early April 2004 that killed 47 people in Tashkent and Bukhara. In light of domestic and international threats, the government has implemented intense security measures such as establishing security checkpoints, sharply restricting access to certain streets and buildings, and deporting nationals of suspect countries. ¶60. Supporters of extremist groups such as the Islamic Movement of Uzbekistan (IMU),al-Qa'ida, and the Eastern Turkistan Islamic Movement remain active in Central Asia. These groups have expressed anti-U.S. sentiments. On December 1, 2001, the Uzbek government imposed travel restrictions on large parts of the Surkhandarya province bordering Afghanistan, including the border city of Termez. Though the border between Uzbekistan and Afghanistan is officially open to traffic, in reality Uzbeks need permission from the National Security Service (NSS) to cross the border, and only select Afghans are allowed into Uzbekistan. -------------- Corruption -------------- ¶61. Uzbek law prohibits corruption, and officials accused of corruption are subject to prosecution. A number of officials have been prosecuted under these laws. Despite these measures, there is considerable anecdotal evidence that officials, who have considerable latitude in interpreting regulations, supplement their salaries through bribes. Several major incidents of bribe solicitation have been reported to U.S. officials. Foreign investors who refuse to pay bribes have experienced difficulties. ¶62. U.S. businesses have cited corruption as one of the main obstacles to foreign direct investment in Uzbekistan. Lack of transparency in bureaucratic processes, including tenders, and limited access to currency convertibility, encourage corruption. Uzbek law does not forbid government officials from acting as "consultants," a common method of extracting payment. ¶63. Three main sections of the government are tasked with fighting corruption: the NSS, the Ministry of Internal Affairs (MVD),and the General Prosecutor's Office. Uzbekistan is not a signatory of the OECD Convention on Combating Bribery or the UN Anticorruption Convention. In its 2007 Corruption Perceptions Index, Transparency International ranked Uzbekistan near the bottom (175th place, ahead of only Myanmar, Somalia, Iraq and Haiti). -------------- Bilateral Investment Agreements -------------- ¶64. Uzbekistan has signed bilateral investment or free trade agreements with a total of 47 countries, including China, the Czech Republic, Egypt, Finland, France, Georgia, Germany, India, Indonesia, Israel, Italy, Japan, the Republic of Korea, Kuwait, Malaysia, the Netherlands, Pakistan, Poland, Russia, Saudi Arabia, Slovakia, Switzerland, Turkey, the United Kingdom, and the United States. Among these, several agreements, including those with India, Italy and the United States, have not yet entered into force. In 2004, Uzbekistan and Russia signed a Strategic Framework Agreement, that also includes free trade and investment concessions. In November 2005, the government signed an alliance agreement with Russia, with provisions for economic cooperation. Uzbekistan and Ukraine also agreed, in 2004, to remove all bilateral trade barriers. In 2006, Uzbekistan began the accession process to the Eurasian Economic Community (EURASEC). At the end of 2007, it had ratified less than half of the necessary documents. ¶65. The "Treaty between the government of the Republic of Uzbekistan and the government of the United States of America concerning the Encouragement and Reciprocal Protection of Investment" was signed in Washington, D.C., on December 16, 1994, and ratified soon after by the Uzbek Parliament. The U.S. government, however, has not acted to bring this agreement into force, and is unlikely to do so until the investment climate in Uzbekistan significantly improves. In 2004, Uzbekistan signed the regional Trade Investment Framework Agreement (TIFA) with the U.S. Trade Representative's Office and its four Central Asian neighbors. -------------- OPIC and Other Investment Insurance Programs -------------- ¶66. The Overseas Private Investment Corporation (OPIC) has been working in Uzbekistan since the signature of the bilateral investment incentive agreement in October 1992. Over the course of its operations in Uzbekistan, OPIC exposure has totaled 229 million USD for six projects. As of January 2007, at least two loans - to a hotel and a school - were active. OPIC supports U.S. investment in developing countries and emerging markets by managing risk with political risk insurance, providing financing through direct loans and loan guaranties, and working with private capital through OPIC-supported private-equity investment funds. (www.opic.gov) ¶67. The estimated annual exchange rate used in Uzbekistan varies from institution to institution. The exchange booth rate was USD 1/1,302 soum, as of December 31, 2007. While overall the soum has greatly deflated against the dollar since the 2003 availability of currency conversion, currently it is moderately depreciating; the Economist Unit forecasts the soum to reach 1,400 to the dollar by ¶2008. -------------- Labor -------------- ¶68. Literacy in Uzbekistan is officially almost universal at 98 percent, and workers are generally well-educated and trained, although with skills transferred from the Soviet era. Most local technical and managerial training does not meet international business standards, but foreign companies engaged in production report that Uzbek workers learn quickly and work effectively. Foreign firms report that younger Uzbeks are more flexible in adapting to changing international business practices but are also less educated than their Soviet-trained elders. The Common Country Assessment, published by the UNDP in 2003, noted that declining access to education among rural youth, especially girls, was causing a decline in the education level across the country. In addition, widespread corruption in the education sector has also lowered educational standards due to the widespread practice of purchasing grades and even entrance to prestigious universities and lyceums. ¶69. Some American companies offer special training programs in the U.S. to their local employees. With the closure or downsizing of many foreign firms, it is easy to find qualified, well-trained employees, and salaries are low by western standards. In the last few years there has been a dramatic increase in the number of workers migrating to Russia and Kazakhstan, among other countries, leaving less qualified workers at home to fill in the gaps. Corporate income taxes were reduced in 2006 and in 2007 to 10 percent. The mandatory insurance payroll deduction dropped from 25 percent in 2006 to 24 percent in 2007. The government plans to further cut tax rates and lessen the tax burden in 2008. It adopted a new version of the tax code in January 2008 (see paragraph 15). Salary caps, which the government implements in an apparent attempt to prevent firms from circumventing cash withdrawal restrictions, prevent many foreign firms from paying their workers as much as they would like. ¶70. Labor market regulation in Uzbekistan is similar to that of the rest of the former Soviet Union, with all rights guaranteed but some rights unobserved. Cases of workers striking include the following in 2003: Turkish construction workers striking against their Turkish employer over working conditions; textile workers who picketed in front of the Ministry of Light Industry due to nonpayment of wages; and large-scale bazaar strikes in light of stark increases in stall fees and an increase in taxes on imported products. In 2004, more unrest and dissatisfaction from enforcement of overzealous trade regulations caused unrest in bazaars in March, and again in November. However, after the May 2005 events in Andijon, there have been few large public displays of dissatisfaction. ¶71. Some European firms have initiated boycotts of Uzbek cotton products on the grounds that child labor has been used in the cotton harvest. The government states that it has long been accepted practice to use high school and university students in the annual harvest. Sometimes children under fourteen, especially from rural areas, participate in harvests, and this has led to charges of child labor. The extent of this problem is disputed, but some independent observers, including the International Labor Organization, report that it is improving. -------------- Foreign Trade Zones/Free Ports -------------- ¶72. Uzbekistan has no maritime borders. The law on free economic zones passed on April 25, 1996, envisaged the establishment of free trade zones including consigned warehouses, free customs zones, and zones for the processing, packing, sorting and storage of goods. However, these zones have yet to be established. The Ministry for Foreign Economic Relations, Investment and Trade (MFERIT) indicated that it is waiting for major investors to develop projects before establishing these. -------------- Foreign Direct Investment Statistics -------------- ¶73. Uzbekistan projects foreign direct investment (FDI) in 2008 will be $1.435 billion. Of this, the government anticipates $628.63 million will go to the energy sector, including $562.8 million to the oil and gas sector; $85.2 million, to the textile sector; $160.8 million, to communications; and $62.37 million, to the transport sector. According to government statistics, FDI in the first half of the year grew 120 percent to $416.7 million, and total FDI reached $308.9 million, up 140 percent year-on-year. The government attributes the rise in FDI to the entrance of new foreign telecom providers and investments by Russian energy firms. The government includes international loans and grants in its FDI accounting, and its statistics are therefore not reliable. The European Bank for Reconstruction and Development (EBRD),in contrast to the government, estimates 2005 FDI of USD 211 million and 2006 FDI of USD 250 million. EBRD figures for 2007 were not available. According to government figures, Uzbekistan's largest trading partners are Russia, Turkey, South Korea, Kazakhstan and China. ¶74. From Uzbekistan's independence in 1991, U.S. firms have invested roughly USD 500 million in Uzbekistan. 2007 was a difficult year for many foreign investors, especially U.S. companies. Due to declining investor confidence and changes to Uzbek legislation, numerous international investors have left the country or are considering leaving. Newmont Mining, the largest U.S. investor, and Coscom, a large cellular provider, both had extended difficulty with the government and left the country. Caterpillar Tractors pulled out in late 2006. Chevron-Texaco set up operations in 1992 and is focusing on producing lubricants for the Uzbek market. It remains in business in Uzbekistan. Many non-U.S. foreign firms have had problems, including UK-based Oxus Gold and two Israeli companies. Shares or assets of these companies or their residual operations are routinely acquired by well-placed Uzbek insiders. The remaining large foreign investors include Swiss-owned Nestle, UK-owned British American Tobacco, Russian-owned Gazprom, and Russian-owned Lukoil. -------------- WEB RESOURCES -------------- ¶75. WWW.MFER.UZ WWW.SOLIQ.UZ WWW.EBRD.ORG WWW.WORDLBANK.ORG WWW.GOV.UZ //BISNIS.DOC.GOV WWW.UZREPORT.COM WWW.UZ WWW.USEMBASSY.UZ WWW.EXPORT.GOV NORLAND