UZBEKISTAN: SPECTER OF CORRUPTION STIFLES

C O N F I D E N T I A L TASHKENT 000771

SIPDIS

E.O. 12958: DECL: 07/03/2018
TAGS: PGOV PREL KCOR ECON BTIO EPET SOCI UZ
SUBJECT: UZBEKISTAN: SPECTER OF CORRUPTION STIFLES
ENTREPRENEURSHIP

REF: TASHKENT 113

Classified By: Political Officer Tim Buckley for reasons 1.4 (B,D)


1. (C) Summary: On July 1 poloff met with an affluent,
well-connected young acquaintance from Bukhara whose extended
family has successfully established a syringe-making factory.
The family is also planning to diversify and start another
factory to manufacture diapers. The young man wants to start
a luxury inter-city bus service in Uzbekistan, for which the
Korean Import-Export Bank has agreed to extend credit;
however, he would have to risk the existing businesses as
collateral. He has seen first-hand how corruption can ruin a
business but knows what it takes to succeed in this
environment. Nonetheless, he is rightfully afraid that
powerful actors will either exact too much of the pie or
squeeze him out altogether. He also offered insights about
dubious higher education credentials in Uzbekistan. This is
an interesting case study in how the omnipresent specter of
corruption in Uzbekistan stifles entrepreneurial activity
even among the privileged classes. End summary.

Syringes and Diapers
--------------


2. (C) Poloff, who previously served as a Peace Corps
Volunteer in Bukhara, met with an acquaintance who graduated
from the same high school where poloff taught English
classes. The 24-year old young man is bright, fluent in
English (as well as Russian, Uzbek, and Tajik),and hails
from an affluent and therefore well-connected family. He
drives a USD 15,000 Daewoo Nexia for which he paid upfront in
cash. He recently relocated to Tashkent, where there are
better business contacts, and he frequently travels
throughout Europe and Asia building client networks. His
extended family has successful enterprises: his father is in
the cookie industry, although poloff's acquaintance has been
more closely involved with his uncles and cousins in a
successful syringe-making factory in Bukhara. Employing more
than 80 people in a refurbished factory, it is the kind of
homegrown investment Bukhara sorely needs as a supplement to
tourism.


3. (C) The acquaintance and his relatives are in the process
of refurbishing another factory in Bukhara to manufacture
diapers, which would create decent jobs for nearly 100
additional Bukharans (nonetheless, he said the regional
hokim, or governor, apparently could care less about the
broader economic impact). They deliberated between Chinese
and Italian suppliers for non-woven fibers with which to
produce the diapers, and ultimately chose the Italian
supplier because of its willingness to extend credit.

Raising the Roof
--------------


4. (C) The acquaintance said his extended family is
comfortable with setting up and running businesses in Bukhara
because they know how the system works at the local level.
This involves "the right permissions" through the local and
regional government. He reminded poloff that all Uzbek
businesses "have to have a roof," that is, paid protection
(Note: This is consistent with what we have long known about
even small businesses such as neighborhood bakeries.
Reftel). Rather than extortion from a separate organized
crime ring, in Uzbekistan the "roof" involves direct channels
within the government or its agents in which an enterprise
arranges payments for operating licenses, taxes, and overhead
cuts. This is at least a known quantity, and one just must
be careful not to get too successful and attract attention.


Butterfly Express
--------------



5. (C) The ambitious young man wants to take advantage of
what he sees as a vast untapped market in Uzbekistan --
luxury domestic ground transportation. Indeed, poloff
commiserated from Peace Corps experience about uncomfortable
14 hour bus journeys between Tashkent and Bukhara on stuffy,
overcrowded Soviet-era buses that leave when they are full
(not according to a schedule) and offer terrible service and
unpredictable pricing (spiking during periods of peak
demand). Our acquaintance has seen how better bus networks
operate on his world travels, with Turkey and China being
particularly suitable models. He even designed a logo and
picked out the name -- the Butterfly Express -- and set out
in search of approximately USD 1.5 million in capital. Since
his proposed enterprise involves a broad geographic scale, he
also explained that he would need to negotiate a higher-level
"roof" upfront, which Bukharan agents would have to pass up
the chain to coordinate.

The Cost of Doing Business
--------------


6. (C) Not surprisingly, Uzbek banks denied the loan request.
Impressively, through contacts made on his trips to Seoul,
the acquaintance successfully presented his vision to the
Korean Import-Export Bank, which is willing to provide a
loan, but only with the established businesses as collateral.
This is where the fear factor in Uzbekistan supersedes the
regular risk that entrepreneurs should expect. He is
rightfully afraid that higher powers (he mentioned the
President's daughter, Gulnora Karimova, as an example) will
take notice of his business model and either: A) exact
progressively larger and untenable cuts until the business
fails, and/or B) simply muscle him out of business altogether
in order to take over the market. The young entrepreneur has
no expectation that he can operate such a venture without
paying any "overhead," but the difficulty is trying to
calculate how much corruption he can absorb as a cost of
doing business before it exceeds the breaking point. He is
reluctant to give up the good life he already has with his
family's successful enterprises in Bukhara and will likely
walk away from the plan.

A First-hand Lesson in Uzbek Business Fundamentals
-------------- --------------


7. (C) While the acquaintance was studying at the prestigious
Westminster University branch in Tashkent, he took a job
working with a Canadian-Uzbek venture called International
Petro Chemical. One of the projects was to purchase paraffin
wax, an industrial byproduct with commercial applications,
from the Ferghana Oil Refinery, from where his company would
then ship it overland for resale. There was a contract in
force listing an agreed sales price of USD 450 per ton;
however, in reality the refinery would never sell at that
price. Officially, on the bank records, the transactions
were indeed listed at USD 450, but it was necessary to
personally visit the Ferghana Oil Refinery and pay an
additional USD 100 per ton to the Director in a sealed
envelope. Thus, hidden costs mounted (this is apart from
operational overhead such as permits, shifting tax
requirements, etc) and International Petro Chemical ceased
operations a few months ago and fired its Tashkent staff --
more good jobs lost and investor confidence shaken.

"Free Attendance Policy"
--------------


8. (C) The reason the acquaintance was able to accept the
position with International Petro Chemical was because the
university he was attending offered "a free attendance
policy," in which he could opt out of actually showing up for
his courses. Instead, he regularly picked up handouts "and
of course it was mandatory to sit for the exams."

Nonetheless, he claimed it was an excellent education and
assured me he did attend some courses personally. (Comment:
This type of story is typical of educational institutions in
Uzbekistan, about which poloff can personally attest from
Peace Corps experience. Yet Westminster, commanding
thousands of U.S. dollars in annual tuition and in
partnership with its namesake university in the United
Kingdom, is supposed to be different. Just a few years after
opening its doors it already has established itself as an
elite university, but this young man's experience
demonstrates that academic standards do not appear very
rigorous. Ironically, the real world experience he gained
working with an ill-fated business enterprise was probably
more relevant for an aspiring Uzbek businessman than any
lectures he might have attended. End comment.)

Comment:
--------------


9. (C) This young entrepreneur's story offers a glimpse of
what it takes to be successful on the tilted playing field of
the Uzbek economy as well as an example of how the certainty
of corruption can dull even some elites' appetite to pursue
business opportunities. It is encouraging that there is an
entrepreneurial spirit among Uzbekistan's talented young
generation, but even well-connected rising stars learn early
on that they better not take too many chances. Echoing these
themes, a French businessman who has operated a variety of
real estate, perfume, and other ventures in Uzbekistan since
1993, told the Ambassador recently that good "social"
connections and close adherence to the letter of the law in
Uzbekistan's legalistic context were pivotal in enabling him
to ward off predatory practices from various quarters and
stay in business.

NORLAND