Country reports on investment climate: Kazakhstan 93 C. Kazakhstan Introduction The ESCAP consultant visited Kazakhstan from 11 to 16 September 2002, with UNDP support. He held meetings with relevant government officials, and members of business and international community based in Astana and Almaty. Foreign companies were interviewed and inputs from the investors’ perspective were received from the European Business Association of Kazakhstan. The consultant would like to express his gratitude to all those who provided their time and information to assist him. This chapter is structured as follows. In section 1 trends in economic activity against the background of Kazakhstan’s reform objectives towards a market-oriented economy in the period since gaining independence are reviewed with particular focus on the FDI role and the country’s current performance in attracting investment. Taking into account investors’ views expressed, the country’s strength, weaknesses and opportunities are identified and reviewed. Section 2 reviews the policy and legal framework for FDI in Kazakhstan, along with an analysis of specific standards which apply to foreign investors and relevant laws and policies which are of particular interest or concern to foreign investors including implementation practices. Finally, an overall assessment is made of the policy and operational framework. It is essential to note that as the study is based on data and other materials as of November 2002, the study has not fully reflected the fact that the new Kazakhstan Law on Investment entered into force on 8 January 2003. A brief preliminary analysis of the new Law is provided in annex 1. Based upon the findings of this analysis, section 3 presents some recommendations for the Government of Kazakhstan to consider core issues for improvement of the investment climate. The recommendations address policy and administration issues concerning regulatory system reform, including improvements in governance, transparency and accountability of governmental and local agencies, the judicial system as well as institutional design of investment- related bodies. 94 Foreign direct investment in Central Asian and Caucasian economies: policies and issues 1. National objectives and competitive position (a) The national economy (i) Economic performance and reform Shortly after the break-up of the former Soviet Union in 1991, Kazakhstan began a series of broad-based reforms in an effort to move from a planned economy to a market economy. These reforms include demonopolization, privatization, debt restructuring, lifting profitability controls, price liberalization, customs and tax reform. Kazakhstan also established a securities and exchange commission, liberalized trade, enacted laws on investment, set up a government procurement process, and reformed the banking system. a. Macroeconomic performance and economic growth Implementation of a comprehensive stabilization and reform programme has brought benefits in the form of macroeconomic stability and high inflows of FDI. There have been significant improvements in GDP growth, current account and budget balance in recent years. Real GDP declined severely during the 1990-1995 period in all CIS economies – GDP fell by about 40-60 per cent in Kazakhstan, Kyrgyzstan and other Central Asian countries. In the latter half of the 1990s, growth rebounded, but Kazakhstan was negatively impacted by the Asian and Russian crises and fluctuations in prices for export commodities such as energy and metals in 1998-1999 (see table III.12). Table III.12. Kazakhstan: real GDP trends in selected CIS countries (1991 = 100) Country/region 1995 2000 2001 Armenia 60 77 84 Azerbaijan 42 59 65 Kazakhstan 69 78 88 Kyrgyzstan 55 72 76 Tajikistan 41 41 45 Uzbekistan 82 99 103 CIS 63 68 72 Source: CIS Statistical Committee. Country reports on investment climate: Kazakhstan 95 Since late 1999, Kazakhstan’s economic performance has improved markedly, owing to both a much more favourable external environment and prudent macroeconomic policies. Driven by strong growth in the oil and gas sector and associated spillover effects as well as by increased prices on world markets for Kazakhstan’s leading exports (oil, metals and grain), real GDP grew 9.6 per cent in 2000, up from 1.7 per cent in 1999. Rising oil production supported by the official opening of the Caspian Pipeline Consortium (CPC) in November 2001 and surge of FDI inflows, despite decline in world prices on mineral resources, drove growth in 2001 to 13.2 per cent. GDP growth in 2002 was expected to again be close to 10 per cent. Kazakhstan’s monetary policy has been well managed. Its principal challenges in the last two to three years have been to manage strong foreign currency inflows without sparking inflation. Inflation has in fact stayed under control, registering 9.8 per cent in 2000 and 6.4 per cent in 2001. While as a result of declining international reserves levels at the end of 1998 and beginning of 1999 the Government has floated its currency, the tenge, the resulting devaluation was managed quite well. This eased the downward pressure on foreign exchange reserves and also has made Kazakh industry more competitive versus their main trading partners, particularly the Russian Federation. The post-devaluation exchange rate has remained stable. Reserves have recovered significantly. Strong economic performance and financial health allowed Kazakhstan to make an early repayment all its debt to IMF by paying back about US$ 385 million in 2000; seven years ahead of schedule. Based on experiences of other oil-rich countries, especially Norway, the National Fund of the Republic of Kazakhstan (NFRK) has been created in order to build up assets for future generations and reduce negative consequences for periods of low commodity prices (see box III.5). The upturn in economic growth, combined with the results of earlier tax and financial sector reforms, have markedly improved government finances from the 1998 budget deficit level of 4.2 per cent of GDP to 1 per cent in 2000 and 1.1 per cent in 2001. b. External sector developments The FDI growth has led to increased volumes of extracted oil and gas, employment in new oil and gas fields, and development of the production capacities in the mining sector in the past two years. The related increase in imported intermediate and investment commodities made a major contribution to a sharp 96 Foreign direct investment in Central Asian and Caucasian economies: policies and issues Box III.5. National Fund of the Republic of Kazakhstan One of the most important policy measure taken over the past two years was the creation of NFRK. The Fund collects bonus payments and receipts from privatization of the natural resource sector, a fixed share (10 per cent) of all government income taxes from natural resource projects, as well as all tax revenue above a certain threshold agreed in the budget and determined by the level of commodity prices. For 2001 and 2002 a baseline oil international price assumption of US$ 19 per barrel has been retained. NFRK invests these revenues in foreign assets, thereby sterilizing part of the capital inflows and trade surpluses of the resource sector, and building up assets for future generations and/or a cushion for periods of low commodity prices. As of November 2002, NFRK has accumulated receipts about US$ 1.8 billion (8.1 per cent of GDP). Note: For a more detailed information on NFRK regulations refer to IMF Staff Report 2002. upsurge of imports which in 2001 were 20 per cent above the level of imports in 2000. Implementation of large-scale investment projects have also resulted in a rise of imported international services. Combined with an increase in capital goods imports and a decrease of exports of goods in 2001 as a result of lower oil and other mineral commodities prices, the external current account surplus of 2.3 per cent in 2000 turned into a current account deficit in 2001 of about 7.8 per cent of GDP. The current account deficit in 2001 was easily covered by FDI inflows and some moderate net lending. The external debt stock as of the end of 2001 reached US$ 14.9 billion, up by US$ 2.3 billion from the level at the end of 2000, but down as a share of GDP. The private sector accounts for 74.5 per cent of total external debt, 77 per cent of which are parent company loans to Kazakh subsidiaries mostly in the natural resources sector. International rating agencies have several times upgraded Kazakhstan’s credit ratings. Moody’s Investors Service, after upgrading Kazakhstan’s credit ratings in 2001, recently upgraded them again: Kazakhstan’s foreign currency ceiling for bonds has been upgraded two notches to Baa3 from Ba2, the ceiling for foreign currency bank deposits in Kazakhstan to Ba1 and the rating for the Government’s long-term local currency instruments to Baa1. Moody’s gave all of Kazakhstan’s new ratings a “stable” outlook. Standard & Poor raised the outlook to positive on its BB long-term foreign currency and BB+ domestic currency credit rating in June 2002. Fitch Rating in September 2002 raised the rating for Kazakhstan’s long-term foreign currency bonds from BB to BB+. All agencies’ ratings have “stable” outlook. The ratings reflect Kazakhstan’s strong export earnings, its strong budget position, reform efforts and its quick recovery from the 1998 Russian financial crisis. Country reports on investment climate: Kazakhstan 97 c. Privatization Most SMEs have been privatized, along with most large-scale State companies. Nearly all of Kazakhstan’s major State oil and mining sector companies are at present privately controlled. Meanwhile, many important assets still remain fully or partially in State hands, including the oil and gas pipeline monopoly. In 1997 the Government of Kazakhstan selected the 13 largest enterprises of strategic significance (which in 1999 were reduced to 10) – so called “blue chips” – to be listed on the Kazakhstan Stock Exchange (KASE) and to be offered for privatization. Only limited progress has been recorded in the planned sale of State shares in the past two years, although a minority stakes in the savings bank and in the copper company were sold. More than 300 of the largest enterprises remain fully State-owned, including the national company KazMunaiGas, which has been established by the merger of oil company Kazakhoil with the Oil and Gas Transit Company, railway company KTZ and energy utility CEGOK. Kazak Telecom is also awaiting privatization. These enterprises are natural monopolies and have strategic significance for the national economy, and as a result their sale is currently not considered advisable for the State, especially in view of the budget surplus. d. Land ownership The new Land Law which came into effect in 2001 allows private land ownership of urban land associated with residential or commercial buildings. The law does not allow private ownership of agricultural land; it shortens the maximum term of agricultural land leases from 99 to 49 years. Foreigners are allowed to lease agricultural land for a maximum of 10 years. e. Enterprise reform Kazakhstan’s corporate sector is made up of several distinct groups of enterprises. The first group contains those companies that have attracted a strategic foreign investor. Most of them are located in the energy sector, but there are pockets of FDI in the steel industry, construction and retail sector, the beverages and tobacco industries and some domestic manufacturing. These companies benefit from strong parent support, including financing, and a clear market strategy. In resource-based industries, FDI is naturally export-oriented, but in other sectors, the domestic or regional markets are the main targets. Companies in this group usually operate according to best international practice. 98 Foreign direct investment in Central Asian and Caucasian economies: policies and issues The second group contains large corporations that were partially privatized either to insiders or to foreign investors with an uncertain reputation in their respective industries. The mining and metal processing sectors are particularly strongly represented in this group. Most of these companies have gone through a phase of ownership consolidation, subsequent to which performance improved markedly. Access to external finance has been limited so far owing to the limited track record of the owners, and concerns over corporate governance and integrity. In most companies in this group, the State retains a residual stake which it has so far been unable or reluctant to sell. Given concerns over corporate governance, portfolio investors have shown little interest as the stakes are too small to attract strategic investment, and in many cases the State has transferred its shares into trust management of insiders. As reported by EBRD, most companies tend to have close political connections, and with some, senior government and political figures have direct or indirect business interests. The present cash flow is relatively strong, reflecting underlying long-term competitiveness and in most cases has supported well-structured investment programmes. The third group of companies is composed of privately-owned SMEs, most of which operate in the food industry and light industrial sectors. Production is predominantly domestic market-oriented and most of these companies do not grow beyond a certain maximum size. Access to finance is limited, and a significant proportion probably operates partially or entirely in the informal sector (estimated at 30 per cent of GDP) for fear of harassment by the tax administration and local government officials. This third group so far represents no more than 25 to 30 per cent of total employment, against 60 per cent in the advanced transition economies, although its share has increased rapidly in the last two years. The description of these three groups of enterprises serves to highlight the three transition challenges that Kazakhstan faces in the corporate sector: (i) Improve the investment climate to attract FDI into more sectors of the non-oil economy. Investors have been concerned over the weaknesses in the legal system, the stability of their contracts in relation to domestic policy changes, and generally high levels of red tape and administrative interference. These concerns have not subsided despite the recent economic upswing, and FDI is therefore unlikely to be forthcoming without a more significant policy shift; (ii) Improve levels of transparency and corporate governance in the second group of enterprises to make them attractive for outside investment and allow them to become competitive on a global scale. To achieve this, however, ownership structures need to be fully disclosed, related Country reports on investment climate: Kazakhstan 99 party transactions stopped, and minority shareholder rights protected. The Government should have a direct interest as a shareholder to support these changes; (iii) Strengthen the SME sector, in particular by allowing the most dynamic and competitive enterprises to grow to a sufficient size to reap economies of scale and present real competition to larger domestic companies and importers. This will require further improved access to finance, but above all improvements in the business climate and a reduction in corruption, which tends to hurt SMEs particularly badly. 21 f. Financial sector reform Kazakhstan’s efforts to create a sound financial system and a stable macroeconomic framework have been outstanding among countries of the former Soviet Union. Much progress has been made in creating and implementing an adequate legal framework. In comparison with other parts of the economy, reform of the financial system has been deeper and more effective. However, the financial system is only beginning to intermediate the financial resource flows and direct them to the most promising parts of the factor and product markets. Nevertheless, official policy is clearly supportive of credit allocation on market terms and the further development of legal, regulatory and accounting systems that are consistent with international norms. Owing to the National Bank of Kazakhstan’s (NBK) reform-minded policies leading to consolidation and privatization of the banking sector, the quality of banking sector supervision has increased in recent years, and the number of banks declined from 130 in 1995 to just 38 in 2002. Most domestic borrowers receive credit from Kazakh banks. However, foreign investors find the margins taken by local banks and the security required for credit to be very burdensome. It is usually cheaper and simpler for them to use retained earnings or borrow them from their home country. Kazakh banks have, since 1998, placed Eurobonds on international markets and obtained syndicated loans, the proceeds of which have been used to support domestic lending. Leading Kazakh banks have been able to obtain reasonably good ratings from international credit assessment agencies. All Kazakh banks have been required to meet Basle risk-weighted capital standards. 21 Information on enterprise reform has been derived from: EBRD strategy for Kazakhstan, EBRD, 2002. 100 Foreign direct investment in Central Asian and Caucasian economies: policies and issues The banking sector remains concentrated, with the four largest banks (Kazkommertsbank, Halyk Savings Bank, Bank Turan Alem and the Dutch ABN-AMRO), accounting for about 60 per cent of total sector assets and about 63 per cent of deposits. Some foreign banks, most notably Citibank (United States), have been aggressively entering the Kazakh market and have been successful in attracting blue chips corporations away from the local banks. Smaller Kazakh banks with limited capital resources and less expertise have consequently seen their market shares decreasing. Competition will continue to increase, particularly from foreign banks, but also from domestic private pension funds, which create strong demand for domestic bonds and, therefore, compete with banks in lending. Despite the apparent progress in banking reforms, the current level of intermediation in Kazakhstan remains very low. There is still a lack of confidence in the financial system and in the country’s macroeconomic stability, which leads businesses and individuals to keep their savings offshore or away from the banking system. NBK has been active in its attempts to restore faith in the banking sector. The most notable measures introduced at the end of 1999 included the adoption of a deposit insurance scheme and bank secrecy regulations, important elements to boost public confidence. In March 2000, Kazakhstan adopted measures to limit police and tax inspectors’ access to individual bank account information. Easy access, often unjustified, has been regarded as one of the main obstacles to the growth of deposits in Kazakhstan. With the implementation of these measures, private deposits in the banking system grew from less than US$ 300 million in November 1999 to about US$ 1.5 billion in October 2002. These key measures are expected to have a strong positive effect on the growth of the sector in the medium term. In 1998, Kazakhstan introduced an accumulation pension system that requires all employed persons to contribute 10 per cent of their salary to accumulation pension funds. As of November 2002, 14 private and one State accumulation funds operating in Kazakhstan had approximately US$ 1.5 billion in assets. Following the pension reform, private pension companies are receiving substantial mandatory pension payments, which through asset managers they are required to invest in assets meeting relatively stringent risk and liquidity conditions. At present, the government securities market attracts the largest share of pension fund liquidity, but the continuing decline in yields on State instruments is leading to growing interest among pension fund managers in blue chip domestic corporate bonds. Future diversification of pension funds into foreign assets could also protect the pension fund system from domestic volatility. Country reports on investment climate: Kazakhstan 101 g. Progress in transition The economic reform environment in Kazakhstan provides a mixed picture (see figure III.1). Kazakhstan is among the most advanced reformers in CIS but lags considerably behind the advanced transition economies of Central and Eastern Europe and the Baltic States. Moreover, figure 1 indicates that Kazakhstan has followed the typical sequence of relatively early liberalization and privatization with lagging institutional reforms and limited reform of infrastructure. While the average transition scores are helpful in situating Kazakhstan along the regional scale of reform progress, they hide some important country-specific patterns in economic reform. On the one hand, Kazakhstan boasts the strongest and best-regulated financial sector in CIS, and has made significant strides in the development of non-bank financial institutions. This is a considerable asset in supporting the diversification of domestic production and domestic savings, but the sector will require further strengthening to withstand potential future volatility. On the other hand, the enterprise sector has been relatively slow to restructure while FDI has been limited outside the oil industry. This raises a considerable challenge to improve competitiveness and corporate behaviour among the large domestic corporations, including the “national companies” which are excluded from private ownership. In infrastructure, some important reform initiatives have begun in the transport and energy sectors, while less progress has been made in the telecommunications and water sectors. However, implementation of reform in infrastructure has often been slow. Figure III.1. Reform progress in Kazakhstan, CIS and CEE/Baltic States 4.0 3.5 3.0 Kazakhstan 2.5 CIS average 2.0 CEE/Baltics 1.5 average 1.0 0.5 0.0 Liberalization/ Institutions Infratructure Privatization Source: EBRD Transition Report 2001. 102 Foreign direct investment in Central Asian and Caucasian economies: policies and issues This pattern of economic reform highlights three sectoral transition challenges, which are closely linked to the overall challenge of diversification and improved governance: (i) Further strengthening of the financial sector to make it shock resistant and to allocate effectively growing national savings to the real economy; (ii) Improvement in the competitiveness and corporate governance of large domestic corporations by attracting outside investment, either through FDI or through commercial debt and portfolio equity finance; (iii) Commercialization of infrastructure to attract private investment, maximize efficiency and safeguard public resources for critical investments in social support and human capital formation. (ii) Economic structure and national development objectives During the last three years Kazakhstan recorded substantial economic growth, as the GDP growth rate per year was on average about 11 per cent. However, about 90 per cent of the growth derives from oil and oil-related businesses. Kazakhstan has world class natural resources including oil, natural gas, coal, uranium, gold, aluminium, lead, copper, zinc, iron ore, etc. Of all the potential investments, oil has emerged as the key sector to ensure long-term economic growth. With its crude oil reserves estimated at 30 billion barrels, Kazakhstan has slightly higher reserves than Mexico, representing roughly 45 per cent of the reserves of the Russian Federation, 11 per cent of Saudi Arabia’s and almost three times the size of Norway’s. The recent discovery of the potentially huge Kashagan oil field under Kazakhstan’s portion of the Caspian seabed has created an expectation that Kazakhstan will become a major oil exporter in the medium term. In the early 1990s many international companies recognized that there is a strong risk in not being part of the potential development of these assets. As a result, Kazakhstan has been fairly successful in attracting FDI. Cumulative inflows up to end-2001 amounted to US$ 12 billion. Kazakhstan has attracted around 75 per cent of all FDI into Central Asia. FDI remains concentrated in the oil and gas sector which so far accounted for 69 per cent of the cumulative total of US$ 12 billion over the 1993-2001 period. In 2001, 81 per cent of all FDI was in the oil and gas sector. Kazakhstan has currently entered into a new phase, where the most important objective is to ensure sustainable growth. Owing to the increased oil-related Country reports on investment climate: Kazakhstan 103 revenue Kazakhstan is at present in a more favourable position. At the same time, the economy is exposed to potentially greater risk, given the increasing weight of the oil sector and the volatility of prices. In this regard, during the last 4-5 years the Government and President have become increasingly concerned about the economy as the non-oil and non-minerals business sectors are still in their early stages of development. The main objectives and future directions of Kazakhstan’s development are comprised in documents formulated under the leadership of the President: “Kazakhstan 2030” and “Strategic Plan of Development up to 2010”, in which the issue of diversification of industry and development of priority non-oil sectors was accorded prime importance. The priority development sectors up to 2010 are agriculture, timber and timber-processing industries, light and food industries, tourism, housing construction and infrastructure. In the oil and gas sector priority is given to the construction of pipelines and development of the industrial infrastructure. In oil-related services and in the non-oil sector first-rate importance is placed on the development of businesses by local investors. (b) Objectives, trends and performance in relation to FDI (i) FDI objectives The Government of Kazakhstan has placed a paramount importance to the attraction of FDI in order to insure sustainable economic growth and modernization through the influx of foreign capital, technologies and expertise. In this regard, the Government’s goal is to establish an open and liberal regime for FDI, including guarantees of national treatment, non-expropriation, repatriation of funds, stability in the legal regime, access to international arbitration and incentives in certain priority sectors. Moreover, as is clearly stated in government strategic document “Kazakhstan 2030”, the country’s aim is to establish a more liberal and attractive investment climate than in other regional neighbouring States in order to rank Kazakhstan as one of the first countries throughout the world with regard to volume and quality of attracted FDI by attracting as many of the major transnational and global companies as possible. In accordance with the investment legislation a range of incentives is offered to foreign investors in priority sectors. Besides the extractive resources sector, the country’s priority sectors for FDI are: 104 Foreign direct investment in Central Asian and Caucasian economies: policies and issues a. Industrial infrastructure; b. Processing industries; c. Astana city/infrastructure; d. Housing, the social sector and tourism infrastructure; e. Agriculture. One of the specific features of Kazakhstan’s strategy is a policy geared towards the protection of domestic infant industries from foreign competition and the forging (mostly with the State support) of closer linkages between the large foreign investors in the resource sectors and domestic suppliers. The Government is keen on emphasizing increasing domestic content in investments, particularly in the oil and minerals sectors. With favourable improvements in the economic situation, the Government has begun to make changes in its policy which has resulted in a draft of an investment law submitted for consideration by Parliament. In the draft investment law the Government plans to eliminate stability clauses for foreign investors who come to Kazakhstan after the enactment of the new law. The new law would also limit recourse to international arbitration of investment disputes. (ii) FDI inflows In 2001, net FDI amounted to US$ 2,760 million, more than twice the number of US$ 1,250 million in 2000, bringing the total cumulative investment to US$ 12.104 billion since 1993 (see table III.13). The oil and gas sector attracts most investment, accounting for around US$ 1 billion per annum. (iii) Sources of FDI The United States companies are the main investors in the country comprising 33.7 per cent of the total cumulative investment during 1993-2000. They have been particularly active in oil and gas ventures and business services, as well as in power generation, mining, food processing and tobacco projects. Chevron Texaco, an American company, has invested around US$ 2 billion in the Tengizchevroil joint venture that was formed as part of a 40-year, US$ 20 billion agreement signed in 1993. Another major oil project is the Offshore Kazakhstan International Operating Company (OKIOC), an international oil and gas consortium comprising nine companies, which has invested more than US$ 600 million in oil and gas exploration. Exxon Mobil is another big investor with investments worth US$ 1.8 billion since 1993. The second largest foreign investor is the United Country reports on investment climate: Kazakhstan 105 Table III.13. Kazakhstan: FDI inflows (net), various CIS countries, 1993-2001 1993-2001 2001 Total Total Country Millions of Per capita Millions of Per capita Percentage US dollars US dollars of GDP Armenia 640 168 70 18 4.0 Azerbaijan 3 773 472 227 28 4.0 Kazakhstan 12 104 872 2 760 185 15.0 Kyrgyzstan 453 92 22 4 0.7 Tajikistan 127 20 22 4 2.0 Uzbekistan 987 40 71 3 0.9 Source: UNCTAD, IMF, central banks. Kingdom, with about 13 per cent of total investment, followed by the Republic of Korea with 12 per cent of the total cumulative investment. China, Italy, Turkey, Canada and Japan are other large investors in the country (see table III.14). Table III.14. Sources of FDI in Kazakhstan, 1993-2000 (Percentage) Region/country FDI inflows Developed countries United States of America 33.7 United Kingdom (including Virgin Islands) 14.8 Italy 4.1 Turkey 4.1 Canada 3.1 Japan 2.4 Germany 2.1 Developing countries Republic of Korea 12.4 China 4.4 Indonesia 2.2 Others 16.7 Source: IMF, National Bank of Kazakhstan. 106 Foreign direct investment in Central Asian and Caucasian economies: policies and issues (iv) Sectoral distribution of FDI FDI remains concentrated in the oil and gas sector which so far has accounted for 69 per cent of the cumulative total of US$ 12 billion over the 1993-2001 period. In 2001, 81 per cent of all FDI was in the oil and gas sector. Ferrous metallurgy accounted for 20 per cent of cumulative FDI in the period 1993-1999. Energy, non-ferrous metallurgy and food processing have attracted 3.7, 3.8 and 3.4 per cent respectively. Investment in the services sectors continues to be low (table III.15). Table III.15. Kazakhstan: sectoral distribution of FDI stock, 1993-1999 (Percentage) Sector FDI stock Oil and gas 54.4 Ferrous metals 20.1 Non-ferrous metals 3.8 Energy 3.7 Food 3.4 Communications 2.3 Others 12.4 Source: IMF, National Bank of Kazakhstan. (v) Performance of FDI The impact of FDI inflows in Kazakhstan on economic growth, and on improvements in trade balance and balance of payments, and most other important macroeconomic indicators has been positive. At the same time, it could be relatively too early to judge the extent to which established FDI is having an impact on the local economy through backward linkages. FDI can stimulate technology transfer and technological capacity-building, as well as human resources development. In this regard, the Government is pursuing a policy of establishing closer linkages between the large foreign investors in the resource sectors and domestic suppliers. The active cooperation between some large foreign investors in the resources sector with local companies has resulted in established linkages leading to the development of technological capabilities of domestic enterprises. Country reports on investment climate: Kazakhstan 107 In this regard, Karashganak Integrated Organization (KIO), a consortium of Texaco (United States), British Gas (United Kingdom), Agip/Eni (Italy) and Lukoil (Russian Federation), is implementing a programme intended to increasing the domestic content in the Karashganak project on development of a huge oil and gas field in western Kazakhstan. At present, KIO has concluded contracts on the supply of goods and services with more than 400 local companies. In 2001, such contracts with local companies represented about two-thirds of all new contracts signed by KIO amounting to about US$ 150 million. The volume of goods and services supplied by local companies to KIO increased seven times to US$ 430 million in 2001, constituting 32 per cent in overall volume of supplied goods and services, from US$ 59 million in 1998 (21 per cent). With strong support from KIO, western companies having long-term contracts with KIO have signed nine agreements with local companies on cooperation in the implementation of those contracts, and other four agreements would be signed in the near future. Moreover, KIO is starting two new projects on the building of plants for manufacturing of pipes for the oil and gas sector with cooperation of local companies. (c) Strengths, weaknesses and opportunities (i) Strengths Kazakhstan is, of course, regarded by foreign investors as an emerging market rather than a developed market, including oil and minerals sectors, and its strengths are viewed from that standpoint. Assessment of Kazakhstan as an economically viable and profitable, as well as politically stable environment dominates among the experts familiar with the Central Asian region. The following factors were highlighted as Kazakhstan’s strengths by representatives of foreign investors and independent observers. a. Attractive natural resource endowment Kazakhstan has very attractive huge resources of hydrocarbons and minerals and attractive exploration potential for additional discoveries. Besides oil and gas resources which have emerged as the key sector attracting foreign investors, Kazakhstan has also world class natural resources such as coal, uranium, gold, aluminium, lead, copper, zinc, and iron ore. Kazakhstan also has abundant resources of land which is suitable for agriculture, but some areas are heavily dependent on irrigated water which may have a high economic cost. 108 Foreign direct investment in Central Asian and Caucasian economies: policies and issues b. Relatively large domestic and regional market Kazakhstan is the largest economy in Central Asia, and with a population of nearly 15 million, and GDP and FDI growing at a high rates, Kazakhstan is seen as presenting a sizeable market for investment not only in the extractive sector but also in infrastructure, consumer goods, and services, especially in those areas where foreign supply through imports is not profitable because of large distances and/or high transport costs. Kazakhstan is a transit country with great potential to become a major transit route for the transit of goods between the Russian Federation, Central Asian countries and China. Transit flows include gas volumes transited through existing transit pipelines connecting Turkmenistan and Uzbekistan with the Russian Federation. Kazakhstan’s location in close proximity to the emerging markets of the Russian Federation, Central Asia and China presents opportunities for the country to serve as a hub for transport and other services, as well as to serve as an export platform. c. Educated, skilled and motivated workforce Established foreign investors in Kazakhstan are uniformly impressed with the levels of education and skills of the workforce and their high level of motivation. d. Stable macroeconomic situation Prudent macroeconomic policy, a stable macroeconomic situation in Kazakhstan, and a stable currency are generally viewed as positive factors by prospective investors. (ii) Weaknesses Generally, the geographic location of Kazakhstan as a landlocked country is not viewed by investors and experts as either a strength or a weakness. On the other hand, the weaknesses in public policy, legislation and its implementation resulting in unfavourable business conditions are identified as significant weaknesses. a. Geographic location Kazakhstan is a landlocked country, which is a significant weakness for the development of any export-oriented industry, especially for industries based on the processing of imported commodities for re-export. The Government has sensibly emphasized Kazakhstan’s position as being at the crossroads between East and West implying the ability to supply either markets, and to benefit from Country reports on investment climate: Kazakhstan 109 being a linkage in trade between the areas. On the other hand, Kazakhstan can be perceived as being equally remote from the major markets of both East and West. Kazakhstan’s dependence on other countries for overland transport (road, rail and pipeline) is a significant current weakness for attracting FDI in oil and minerals sector. Kazakhstan’s landlocked position must be considered as a weakness in attracting inward investment for global markets. To counterbalance this, Kazakhstan is a large country in the Central Asian region neighbouring the Russian Federation and China which is a potential strength. b. Infrastructure Kazakhstan as a vast, thinly populated, landlocked country faces particularly salient needs for infrastructure improvement. First and foremost among these needs is transport and telecommunications. Furthermore, while the country has extensive energy resources, the energy transport infrastructure is underdeveloped, both for export and for delivery to domestic markets. Significant improvements are in need in the power sector and in municipal utilities. c. Difficult business environment Clearly, Kazakhstan presents a difficult business environment, so different from investor expectations and international practices that investors are hesitant to commit their capital, with the exception of those in the extractive sectors. The Government of Kazakhstan has made great strides in improving foreign investment legislation. But key concerns remain, including the vagueness of laws, contradictory legal provisions and poor implementation. Another leading competitive disadvantage of the business environment in Kazakhstan is bureaucratic “red tape”. Investors claim to have encountered excessive “red tape” and other delays which hinder the establishment of new investment, the conduct of ordinary business operations and reinvestment. Transparency in the application of laws remains a major problem in Kazakhstan and an obstacle to expanded trade and investment. While foreign participation is generally welcomed, some foreign investors allege that the Government is not always even-handed and sometimes reneges on its commitment. Corruption is widespread and encouraged by the gaps left in the legal system, the broad discretion given to civil servants and the relatively low wage levels in the public sector. 110 Foreign direct investment in Central Asian and Caucasian economies: policies and issues (iii) Opportunities Kazakhstan is presented with two strategic opportunities: to develop industry in accordance with national advantages and the opportunity to become the preferred investment location in the region. a. The preferred investment location for a regional market Kazakhstan has the opportunity to become a production and services base for the wider regional market of 56 million people in Central Asia. It has attracted a large amount of FDI, including investment of reputed international investors which could bring with them financial resources, know-how and best international practices. Through backward linkages capacity of local companies and managers could be substantially improved. Another advantage is the perceived strongest and best-regulated financial sector in Kazakhstan. These could give head start for Kazakhstan’s non-extractive sector in comparison to other countries in the region. In addition, Almaty has the opportunity to be the regional office for professional and trade service firms, and in the longer term may develop as a key financial centre and capital market for the region. b. Ensuring sustainable economic growth Due to the increased importance of the oil sector and the volatility of oil prices, Kazakhstan’s economy faces a challenge to ensure sustainable growth. In this regard, the economy has to become more diversified to better withstand future commodity price shocks and provide economic opportunities to the population outside the resources sector. The non-oil and non-minerals sectors are currently perceived by international investors as relatively unattractive. Thus, the investment climate has to be improved and all concerns of investors are to be addressed, including a wide range of regulatory issues. (d) Overall assessment of current competitiveness and FDI Kazakhstan has a huge natural and sufficient human resources endowment and a relatively large population, and has attracted considerable amounts of FDI in the resources sector. In terms of size of natural resource deposits and attracted FDI, Kazakhstan’s economy ranks as outstanding among the Central Asian countries. Country reports on investment climate: Kazakhstan 111 Kazakhstan has also the opportunity of becoming the preferred regional location for FDI in the non-extractive sector taking into account the relatively more advanced reform process in different sectors of the economy, stable macroeconomic conditions and growing backward linkages through which the capacity of local companies and managers could substantially be improved. In order to ensure sustainable economic growth, Kazakhstan also needs to achieve a more diversified economy through modernization of its priority sectors and development of physical infrastructure to ease access to domestic and regional markets. In turning these opportunities into reality, Kazakhstan is facing serious constraints in the form of weaknesses in the policy and administrative regime governing business. These weaknesses are major obstacles to accelerating FDI in the non-extractive sector and diversifying Kazakhstan’s economy. To address this challenge Kazakhstan has to improve its investment climate significantly and continue structural reforms including improvements in transparency and corporate governance, privatization and commercialization of public utilities, and liberalization of trade policy. 2. Policy and operational framework for FDI (a) The overall legal framework Kazakhstan enacted four major pieces of legislation relating to foreign investment. These are: the Law on Foreign Investment (1994, amended in 1997); the Law on State Support for Direct Investment (1997); the Law on Government Procurement (1997) and the Tax Code of 2001. These laws provide for non-expropriation, currency convertibility, guarantee of stability in the legal regime, transparent government procurement, and incentives in certain priority sectors, including industrial infrastructure, processing industry, the city of Astana, housing, the social sector, tourism and agriculture. Kazakhstan’s generally liberal investment regime means that no sectors of the economy are closed to investors, although there are some sectoral limitations, including limits in the banking and insurance sector. In the banking sector the total registered charter fund of all banks with foreign participation is limited to 50 per cent of the overall registered charter fund of all banks in Kazakhstan. In addition, under the Law on Insurance (2000), while foreign legal entities, including foreign insurance organization and foreign citizens, are permitted to 112 Foreign direct investment in Central Asian and Caucasian economies: policies and issues participate in insurance and reinsurance organizations in Kazakhstan, the maximum foreign participation permitted is 50 per cent. Restrictions also exist on foreign ownership of land in Kazakhstan (see section on property rights). Other provisions are as follows: (i) National treatment The foreign investment laws provide for, inter alia, guarantees for national treatment and non-discrimination among foreign investors. Generally, Kazakhstan does not restrict investment in any sector and it does not subject foreign investment to any prior authorization requirements. Despite the general guarantee, at present there exists a possibility of denial of national treatment in the petroleum and minerals sectors. The Kazakh authorities at present pursue a policy geared towards the protection of domestic infant industries from foreign competition and the forging (mostly with State support) of closer linkages between the large foreign investors in the resource sectors and domestic suppliers. September 1999 amendments to the oil and gas law requiring oil companies to use local goods and services represent an extension of this trend. The Government continues to emphasize increasing domestic content in investments, particularly in the oil and minerals sectors. (ii) Privileges and preferences Under the investment laws investment preferences could be provided in priority sectors in the form of tax preferences and/or grants of property on the basis of an investment contract. More specifically the Committee on Investment under the Ministry of Industry and Trade is authorized to grant the following incentives for direct investments: a. Property tax exemptions for a period up to five years; b. Income tax exemptions for a period up to five years; c. Exemptions or reductions in customs duty rates on the equipment, raw materials and other materials necessary for completion of the investment project. The priority sectors approved by the Government in this regard include the following sectors: Country reports on investment climate: Kazakhstan 113 a. Industrial infrastructure; b. Processing industries; c. Astana city/infrastructure; d. Housing, the social sector and tourism infrastructure; e. Agriculture. (iii) Concessions In the oil and minerals sectors concessions are provided to investors on the basis of specific provisions of relevant legislation. According to the Law on Mining (1996, as amended in 1999) and the Law on Oil (1993, as amended), concessions may be granted for the mining of natural resources and oil and natural gas for up to 45 and 40 years respectively. (iv) Stability of legislation The most significant guarantee for investors is provided by the Law on Foreign Investment. Article 6 provides for protection against adverse changes in the law for a 10-year period following investment. For long-term contracts of more than 10 years, the guarantee runs until the expiry of the contract. However, the guarantees do not extend to changes in legislation related to matters of national security, environmental protection and public health. Additionally, the guarantees do not apply to amendments in the legislation related to issues of taxation and other measures of State regulation of excisable goods. The said provisions of the Law on Foreign Investment on guarantees of stability of legislation are significantly weakened with the entering into force of the new Tax Code in 2002. Article 285.1 of this Tax Code contains contradicting provisions: while the first paragraph of the article states that taxation conditions, established in subsurface use contracts, may be amended upon mutual agreement of the parties in case of changes in the legislation, the second paragraph indicates that in case of changes resulted in benefits to taxpayers, the taxation conditions shall be amended in order to restore the original economic interests of Kazakhstan. The issue of the stability of tax regimes in subsurface use contracts has generally become less clear as a result of changes in the Tax Code, and precedents for the implementation of Article 285 have yet to be established. The issue of stability of legislation remains a key issue in view of the submission in the second half of 2002 of a new Investment Law to Parliament for 114 Foreign direct investment in Central Asian and Caucasian economies: policies and issues consideration by the Government of Kazakhstan. According to the last publicly- available version of the draft law, the law should replace both of the investment laws and is intended to give equal rights to domestic and foreign investors. The foreign investors in Kazakhstan are concerned that the new Investment Law would eliminate many benefits that foreign investors enjoyed under the 1994 Foreign Investment Law, including guarantees against changes in Kazakhstan’s legislation. According to the Draft Law, the stability clause (i.e., guarantee of stability of legislation) may only apply where the investments were made prior to the introduction of the Draft Law, providing the applicability of the existing legislation, but providing no stability guarantee for new investments. The new law would also limit recourse to international arbitration of investment dispute. (v) Foreign Investors Council For investors to renew their interest in different sectors in Kazakhstan, including the non-oil and non-minerals sectors, a range of regulatory issues must be addressed. However, the Government is working together with investors, particularly under the auspices of the Foreign Investors Council (FIC) to find solutions to such problems. FIC was established in 1998 to encourage foreign investment in Kazakhstan and to provide a forum for investors and the Government to express and exchange their views with regard to investment issues in the country. The Council is chaired by the President. The members of the Council representing the Government are the Prime Minister, the Minister of Foreign Affairs, the Chairman of the National Bank, the Chairman of the Committee on Investments under the Ministry of Industry and Trade (the successor of the Agency on Investment). The FIC members representing the business community are representatives of international financial institutions and foreign companies at the level of Chief Executive Officers or their deputies. The FIC meetings take place once or twice a year. The Council makes decisions through open voting by the simple majority of all members present at the meeting. There are four joint working groups within FIC aiming to establish an investment climate of high standards. Among the issues discussed in the plenary sessions of FIC were stability of contracts and the necessity of achievement of balance of interest of contracting parties, investment image building, work permits for the expatriates, simplification of licensing and permissions, etc. (vi) Nationalization/expropriation The 1994 Foreign Investment Law outlines a clear process for legal expropriation. Direct expropriation may take place only in the public interest under the terms of the Foreign Investment law, on a non-discriminatory basis, Country reports on investment climate: Kazakhstan 115 and with the payment of “prompt, adequate and effective” compensation. Compensatory payment must be at fair market value with interest in the currency in which the investment was made. The amendments to the Foreign Investment Law of 1997 substantially enhanced the guarantees against direct and indirect expropriation, unequivocally provided those guarantees to joint venture entities (in addition to their foreign shareholders), and ensured an identical, non-discriminatory compensation regime to investors that suffer either direct or indirect expropriation. Bilateral investment treaties between Kazakhstan and other countries also refer to compensation in the event of expropriation. (vii) Repatriation of funds Under the investment laws foreign investors are entitled to repatriate profits in convertible currency after the payment of taxes and any other levies due. (viii) Settlement of disputes There have been a number of investment disputes involving foreign companies in the past several years. While the disputes have arisen from unrelated, independent circumstances, according to investors, they are all linked to alleged breaches of contract or non-payment on the part of Kazakh State entities. Kazakhstan is still in the process of building the institutional capabilities of its court system. Until this is complete, the performance of courts in the country will be less than optimal. Investors state that further problems exist in having a judgment enforced. The Ministry of Justice is only beginning to establish a judicial system. Given this lack of development, there is ample opportunity for interference in judicial cases. The Government has announced its intention to increase the independence of the judiciary, and judicial reform is pending in parliament. In a recent survey of enterprises in Kazakhstan and other CIS/CEE countries, only 35 per cent of the enterprises were confident that the legal system would defend their contract and property rights in a business dispute.22 The July 1997 amendments to the Foreign Investment Law provide foreign investors involved in disputes with the State with clear and unequivocal access to international arbitration. Access is restricted to arbitration forums located in States that are signatories to the New York Convention for the Recognition and Enforcement of Foreign Arbitral Awards. 22 World Business Environment Syrvey, World Bank, 2000. 116 Foreign direct investment in Central Asian and Caucasian economies: policies and issues Any international arbitration decisions rendered by the International Center for the Settlement of Investment Disputes tribunals, any tribunal applying the United Nations Commission on International Trade Law Arbitration Rules, the Stockholm Chamber of Commerce, and the Arbitration Commission at the Kazakhstan Chamber of Commerce and Industry should, by law, be enforced in Kazakhstan. Despite such safeguards, however, according to investors, there continue to be great practical difficulties for foreign investors in enforcing arbitration decisions against government enterprises in Kazakhstan, particularly given the near-bankruptcy of many such enterprises. The functioning of Kazakhstan’s bankruptcy regime is hindered by a complex bankruptcy law, resulting in considerable misapplication in practice. Passed in 1997, the multiple amendments passed since then have introduced greater complexity to implementation. In general, the Government of Kazakhstan has had a mixed record of addressing investment disputes. Foreign investors have often had to go through protracted negotiations with working-level officials, only to have the highest level of government make key decisions on the future of a given investment. Most investors generally prefer to handle investment disputes privately, rather than make their cases public. (ix) Local content On 7 June 2002, the Government of Kazakhstan adopted Regulations for the purchasing of goods (works, services) required for petroleum operations. According to the Subsurface Use Law and the Petroleum Law, subsurface users are obliged: a. To buy goods (works, services) manufactured by Kazakh entities within Kazakhstan provided that such goods meet certain requirements; b. To give preference to the employment of local personnel. These obligations have been generally referred to as the so-called “local content” requirement. Although the legislation provides for the above requirements, it also refers to “procedures established by the Government of Kazakhstan”, which were not in existence prior to the Regulations coming into force. The Regulations set out an exhaustive list of requirements for local content and detail the tender procedures that must be followed when purchasing goods for petroleum operations. Importantly, the Regulations stipulate that, where the subsurface user fails to comply with the procedures established for the purchasing of goods for petroleum operations, any potential supplier of the goods purchased under the Country reports on investment climate: Kazakhstan 117 violations may sue the subsurface user in accordance with Kazakh legislation. The parties to a purchase transaction may be held responsible for any violation of the Regulations, in accordance with Kazakh legislation. Following their adoption the Regulations became one of the central items of any discussion regarding petroleum operations in Kazakhstan. The President and the Government agreed, therefore, to “fine tune” the Regulations in order to reflect the economic reality and availability of goods (works, services) in Kazakhstan.23 These requirements may be challenged prior to Kazakhstan’s WTO accession negotiations since they appear to breach GATT and GATS rules and the Agreement on Trade-related Investment Measures (TRIMs). (x) Performance requirements Performance requirements, to the extent that they are imposed, are the result of a contract between the individual investor and the Committee on Investment which is currently part of the Ministry of Industry and Trade. They are the quid pro quo for tax, customs duty, or other privileges and benefits, as provided by the Law on State Support of Direct Investments. Typically, an investor’s obligations might include financial obligations, obligations to train local specialists, and contributions to social funds or needs. Performance requirements, in some cases, are central to investment and privatization contracts. Companies are frequently required to pay back wages, implement renovation programmes, including technology transfer, and meet certain production targets. In several instances, the Government has revoked contracts because firms did not follow their performance obligations. (xi) Foreign exchange arrangements There are minimal restrictions on converting or transferring funds associated with an investment into a freely usable currency at a legal market rate. In April 1999, the Government and NBK announced that the national currency would be allowed to freely float at market rates, thus abolishing the previous managed exchange rate system. The National Bank introduced a regulation in 1998 that permits the payment of wages in cash in foreign currency. Foreign investors may convert and repatriate tenge earnings made inside Kazakhstan. 23 Ernst & Young, a Business and Investment Guide, 2002. 118 Foreign direct investment in Central Asian and Caucasian economies: policies and issues (xii) Taxation Kazakhstan’s tax code is considered by tax experts to be among the most comprehensive among CIS countries. In general, taxes are applied universally within the code, allowing only a limited set of exemptions. The code is based on the principles of equity, economic neutrality and simplicity. The new 2001 Tax Code is widely seen as a further step forward in establishing a transparent and effective tax system. VAT rates were reduced from 20 to 16 per cent and social taxes (payroll taxes) from 21 to 11 per cent in 2001. The results of the survey carried out by FIAS show that high tax rates are regarded as a somewhat greater problem than tax administration. Seventy-nine per cent of enterprises regard tax rates to be a significant obstacle to business as compared to 54 per cent firms which perceive tax administration to be an important obstacle. As shown in table III.16, tax rates in Kazakhstan are on average higher than in other CIS countries. Table III.16. Kazakhstan: comparative tax rates in CIS countries Tax Azerbaijan Kazakhstan a Turkmenistan Uzbekistan Withholding 15 15-20 10 20 Pension 1 10 1 2.5 Corporate income 12-35 5-30 8-12 15 VAT 18 16 20 18 Source: Ernst and Young Tax Guide, 2000. a Note: The tax rates for Kazakhstan are according to Tax Code 2001. Although the nominal tax rates of up to 30 per cent may be considered reasonable, the tax base is much wider than in most OECD countries because so few exemptions or deductions are allowed for normal business expenses. For example, deductions for business trips are set at levels normal for “average” rural Kazakhstan, but inappropriate for international travel or urban Kazakhstan. Since independence Kazakhstan has ratified treaties on the avoidance of double taxation with over 30 countries. The 2001 Tax Code simplified and clarified the previous tax code. The new tax code limits the powers of tax authorities and defines the rights of taxpayers more clearly. However, the administration of the tax code and tax treaties has not been as efficient, transparent or consistent as it should be. The Government recognizes this, and has begun a programme of reform. Nevertheless, foreign Country reports on investment climate: Kazakhstan 119 companies often complain of harassment by frequent visits of tax inspectors which seem to have enormous discretionary power. Since January 2001 transfer-pricing legislation has entered into force, which has given tax officials more authority to regulate export-import transactions. This law was enacted to protect the government from the use of transfer pricing by companies to avoid paying taxes in Kazakhstan. Foreign investors are concerned by the legislation’s methods of determining the market price. They also believe that the 10 per cent norm for deviation from world market prices24 as stipulated in the law is overly restrictive, in view of the internationally accepted norm of 20 per cent. (xiii) Protection of property rights With respect to property rights, secured interests in property are recognized under the Civil Code and the 2001 Land Law. Land cadastres (registries) for registering rights in fixed property have been fully established in only a limited number of regions, most notably Almaty and Astana. The use of mortgages on real estate has begun, but legal and banking expertise in this area is limited. In order to popularize the use of mortgages, the central bank is taking steps to develop mortgage-backed bonds. (xiv) Land law Kazakhstan’s constitution stipulates that land and other natural resources may be owned or leased only by Kazakh citizens according to conditions established by law. The 2001 Land Law allows both citizens of Kazakhstan and foreigners to own urban land with commercial and non-commercial buildings and complexes, including dwellings and land used for servicing these building. Under the 2001 Land Law, only Kazakh citizens may own rural land upon which suburban or summerhouses stand as well as non-commercial household gardens. The new law permits only State-owned entities to use land permanently. The maximum period for long-term land use has shortened by new law to 49 years from 99 years as was set forth in the previous law. Foreigners may rent agricultural land for up to 10 years. 24 The Law on State Control over the Use of Transfer Pricing stipulates that if the transaction price deviates from the market price of goods (works, services) by more than 10 per cent in either direction, this could serve as the reason for adjustment (correction) of the base for taxation of a company engaged in such a transaction. 120 Foreign direct investment in Central Asian and Caucasian economies: policies and issues (xv) Trade policy Kazakhstan has liberalized its trade policies and passed many pieces of legislation to begin bringing its legal and trade regimes into conformity with WTO standards. Much work remains to be done in these areas. Kazakhstan submitted its Memorandum on the Foreign Trade Regime in 1996 and the first round of consultations on WTO accession took place in 1997. However, Kazakhstan’s inadequate initial offer on goods and services has slowed down the accession process. The Government tabled revised offers in spring 2001. The Government states that Kazakhstan, being a member of the Eurasian Economic Community (EAEC), would like to coordinate the pace of its WTO accession process with the other members of EAEC that have not yet joined WTO (Belarus, Russian Federation, and Tajikistan). The fifth EAEC member, Kyrgyzstan, joined WTO in 1998. It is hoped that accession by the Russian Federation, the largest economy of CIS, and Kazakhstan, the third largest economy of CIS, to WTO could significantly boost regional trade. Kazakhstan has occasionally resorted to discriminatory policies with respect to imports. For example, in January 1999, Kazakhstan introduced a six-month ban on a range of food, tobacco and milk products imported from the Russian Federation. It also imposed punitive duties (200 per cent) on food and construction materials imported from Uzbekistan and Kyrgyzstan. These measures were taken in response to domestic producers’ complaints of unfair trading practices following devaluations in those countries’ currencies. The punitive import duties on Kyrgyzstan’s goods and the ban on Russian products were dropped in the summer of 1999. The punitive duties on imports from Uzbekistan were abolished in December 1999. Kazakhstan is also a member of ECO, which comprising 10 countries, including Afghanistan, Azerbaijan, the Islamic Republic of Iran, Kyrgyzstan, Pakistan, Tajikistan, Turkey, Turkmenistan and Uzbekistan. In a recent survey on non-tariff barriers in the region carried out by ITC among private sector representatives from ECO countries, road blocks (i.e, delays and additional costs in transit incurred as a result of numerous customs and other inspections check points in each country) have been identified among major non-tariff barriers in the region, and Kazakhstan along with Uzbekistan and Turkmenistan, has been identified as the country with the highest level of constraints related to road blocks. Kazakhstan was also specified as the country with a medium level of openness, in contrast to Azerbaijan and Kyrgyzstan which were identified as the countries with the highest level of openness. Country reports on investment climate: Kazakhstan 121 Kazakhstan permits the import of goods from CIS trading partners and certain developing or least developed countries free of duty or at a reduced rate within the framework of the generalized system of preferences. There are very few quotas and duties on exports. Among the more important is an agreement signed with the EU concerning quotas on textiles. (xvi) Company and other commercial law While Kazakhstan’s commercial laws have been gradually improving over the past four years, they still fall short of standards that are generally acceptable internationally. Kazakhstan’s commercial legal rules that impact on commercial transactions, such as corporate law and secured lending, fare reasonably well compared to more developed countries (see table III.17). Table III.17. Kazakhstan: perception of commercial laws Legal Indicator Survey – commercial laws Reasonably good Adequate Bulgaria Azerbaijan Croatia Belarus Estonia Czech Republic Former Yugoslav Republic of Macedonia Yugoslavia Hungary Georgia Kazakhstan Poland Latvia Russian Federation Lithuania Slovak Republic Moldova Ukraine Romania Uzbekistan Slovenia Inadequate Detrimental Albania None Armenia Bosnia and Herzegovina Tajikistan Turkmenistan Source: OGC Legal Indicator Survey, 2001. Note: Ratings in Legal Indicator Survey include five grades ranking from detrimental in the bottom to very good in the top. However, no country received a rating of “very good”. 122 Foreign direct investment in Central Asian and Caucasian economies: policies and issues Although Kazakhstan’s normative laws do not yet approximate international standards and Kazakhstan lacks adequate institutional support to implement these laws, the country overall compares reasonably well with other transition countries. Based fully on the 2001 EBRD Legal Indicator Survey, which measured the perception of lawyers familiar with Kazakhstan law, the commercial and financial laws of Kazakhstan can be characterized as reasonably good for supporting investment and other commercial activity. Compared with other countries in Central Asia, Kazakhstan’s commercial laws are perceived by lawyers in the field as superior. The commercial laws of Kazakhstan rank as being reasonably good, a standout among the CIS countries, and on par with some of the more advanced transition countries of Central Europe, such as, Hungary, Slovenia, and the Baltic States (including even those which do not have laws that can be characterized as meeting international standards). (xvii) Expatriate employment Foreign workers are required to have a work permit to work legally in Kazakhstan. Such permits are issued in accordance with quotas established by the Government of Kazakhstan. Permits are issued for the employment of foreigners of certain categories and qualifications. Prior to any official application for foreign work permits, employers are required to undertake measures to search for employees on the domestic labour market. These include informing the authorized body of any job vacancies and advertising the available vacancies in newspapers, etc. Obtaining these work permits can be difficult and time consuming. According to a recent FIAS study, it takes a minimum of 30 days to obtain a work permit for a worker, much longer than the average time taken in other countries. Each approval step is time consuming, requiring multiple levels of documentation and health assessments for each employee. Adding to the investors’ risk is the possibility that a potential employee can be rejected without an explanation.25 The issue of work permits for the expatriates was discussed at the plenary sessions of FIC as well as in an FIC joint working group. Foreign investors have expressed concerns about the lack of transparency in determining the quota and the distribution of permits by region, implementation of current regulations, many articles which are simply not implemented, especially in the regions, and a clear imbalance in the allocation of permits. In this regard, FIAS reported that 25 Kazakhstan: Costs of Unnecessary Bureaucratic Procedures and Delays, FIAS, 2001. Country reports on investment climate: Kazakhstan 123 a company with a foreign workforce of 1.5 per cent of its total workforce experienced serious problems getting permits in a given region, while another company with 30 per cent foreign employment has no problem in another region. (xviii) Environmental protection The Law on the Protection of the Environment (1997) is the main law dealing with environmental issues. In particular it stipulates that State authorities must approve business plans for new industrial projects before such projects may commence. The Ministry of Environmental Protection is the main State agency responsible for ensuring compliance with the law. This Ministry has the right to freeze an enterprise’s activities, where it believes that the enterprise is causing harm to the environment. Non-compliance with the environmental laws is subject to administrative, civil and criminal sanctions. (xxi) Main investment agency and other agencies The Committee on Investment was established in 1997 as an independent agency to increase and facilitate investment with the intention of providing a “one-stop shop” for investors. The Committee is also responsible for coordinating state agencies in activities to implement investment projects carried out by preferred investors. With regard to investment projects, the Committee is responsible for the following: (a) Conducting negotiations on the conditions for attraction of direct investment in Kazakhstan, including domestic as well foreign investment, and signing of the contracts; (b) Facilitating obtaining all the permits and other official approval documents necessary for implementation of the projects; (c) Carrying out monitoring processes during the course of implementation of the projects. Moreover, the Committee is also implementing other numerous responsibilities related to improvement of the investment climate, implementation and modification of legislation, image building, investment promotion, etc. Although the Committee was established to facilitate foreign investment, foreign investors are of the opinion that it has had little success in addressing their concerns. The Ministry on Energy and Mineral Resources is responsible for the signing of product sharing contracts in the oil and minerals sectors and facilitating all related activities. 124 Foreign direct investment in Central Asian and Caucasian economies: policies and issues The responsibility of other related ministries and agencies depends on their specific functions and tasks. However, coordination among agencies involved in the registration process and obtaining numerous licences, permits and approvals is not adequate and efficient. In pursuing its policy objectives of diversification of the national industry, Kazakhstan attaches high priority to the implementation of promotional strategies. In this regard, the Kazakhstan Investment Promotion Center, Kazinvest, was established in 1998. In particular, in coordination with the Committee on Investment, Kazinvest is engaged in disseminating information and promotional materials, providing after-investment services for established investors, organizing advertisement and awareness seminars in potential investing countries, etc. In cooperation with other State agencies, in the last two years several investment conferences were organized in Belgium; China; Egypt; Germany; Hong Kong, China; Switzerland; the United Kingdom and the United States. The successful holding of two Eurasian Economic Forums in Almaty in 2000 and 2002 within the framework of the World Economic Forum also facilitated image building of Kazakhstan in this respect. In October 2002 an investment conference named “Astana – the City of Tomorrow” was held with the participation of prospective investors and international investment agencies. Kazinvest is actively establishing contacts with investment promotion agencies abroad, and is a WAIPA member. However, activities of the Committee on Investment and Kazinvest are not sufficient, in particular in providing after-care services as existing investors often complain of excessive bureaucracy, significant delays in obtaining necessary permits and licences and other existing administrative barriers. In view of decreasing global FDI flows during the last two years, Kazakhstan is in need of reinforcing the investment promotional capabilities of government institutions, including provision of services of established investors and ensure increased awareness of target countries and companies of Kazakhstan as an attractive investment destination in priority sectors other than those related to natural resources. (xx) Bilateral and multilateral investment treaties Kazakhstan has bilateral investment agreements in force with 32 countries, including China, France, Germany, Islamic Republic of Iran, Republic of Korea, the Russian Federation, Turkey, the United Kingdom and the United States. Kazakhstan also has over 30 treaties on avoidance of double taxation. Kazakhstan recognizes and is a party to many international treaties and conventions relating to investment. In particular, it is signatory to the Washington Convention on the Country reports on investment climate: Kazakhstan 125 Settlement of Investment Disputes between States and nationals of other States, the New York Convention on recognition and Enforcement of Foreign Arbitral Awards, the Agreement to the Power Charter and European Convention on Foreign Trade Arbitrage. Kazakhstan is a MIGA member. (b) Administrative procedures and practices (i) Procedures for implementation of FDI projects a. Entry process Overall the company registration process in Kazakhstan is cumbersome and involves a fair amount of red tape. On average, the registration process lasts 41 days, ranging from a minimum of 1 day to 75 days (and even more in extreme cases). This process includes registration in the State Register’s Office, Ministry of Justice and the Tax Inspectorate, as well as registration in the State Pension Fund, trademark registration, and registration with the Ministry of Interior Affairs. Time taken to register a company in Kazakhstan is on average higher than that found in many other countries amd areas, such as Malaysia and Hong Kong, China, where the process takes about five days. b. Customs procedures The Customs Code (as updated in 1999) includes general provisions which include the establishment of the customs administration body and a description of its duties, the variation of fees, including specialized customs fees, anti-dumping fees, etc., together with provisions related to customs procedures and privileges. Each year Customs issues a number of orders, regulations and instructions of a general application nature. Neither customs nor any other entity publishes these administrative documents regularly. The paperwork and customs procedures are very complicated, leaving room for significant errors. The computerization of customs procedures remains unfinished. According to investors, moderate to major problems associated with customs administration include creation of artificial complications, excessive paperwork, lengthy delays and unofficial payments to customs officials. Granting customs exemptions stipulated in the Law on Foreign Investment continues to be problematic, because Customs has failed to issue any regulations or instructions for their implementation. Instead, according to investors, Customs decides claims in an ad hoc manner, which has resulted in inconsistent and non-transparent application of the law. The perception of most investors is that the non-availability of information and misapplication of laws can be traced to 126 Foreign direct investment in Central Asian and Caucasian economies: policies and issues the intent to extract unofficial payments. Customs officers are also said to harass enterprises, often abusing power by arbitrarily seizing or blocking exports or imports. Although investors have cited these problems, they also commented that the customs administration has noticeably attempted to improve service provision. c. Other administrative procedures The Licensing Law (1995) established the legal framework for licensing activities in Kazakhstan. It requires the relevant agency to issue a licence within one month of a company’s submitting all required documents. The implementation of the Law has been inadequate. For example, the Government has not yet approved most of the qualification and procedural requirements for issuing licences. This situation has left some businesses vulnerable to inspection bodies, which have threatened them with fines and shut-downs for not having licences that are, in many instances, impossible to obtain legally. In 1998, several additional procedural acts were adopted to implement the requirements of the Licensing Law. However, investors feel that many areas still lack implementing rules. In addition, investors find that the number of licences required for most activities and the frequently revised list of licences lead to confusion and ambiguity in the process and are major obstacles to business. The ambiguous and often arbitrary environment causes instability and uncertainty for investors. According to the recent survey carried out by FIAS,26 in general, consistent with other countries in the CIS region, the average time necessary for starting a business in Kazakhstan is 107 days. Registration and licensing takes 70 days in Kazakhstan. In sharp contrast is New Zealand’s streamlined start-up process which takes only three days and is completed in three steps. The average time spent in dealing with regulatory and administrative procedures in Kazakhstan is 69 days per year, excluding time required to deal with inspecting agencies. Table III.18 provides a breakdown of the time spent on different regulatory procedures. Delays in one or more of these processes significantly increase the cumulative costs of establishing and operating an enterprise in Kazakhstan. (ii) Implementation practice The Government of Kazakhstan has made significant progress in creating a favourable investment climate since its independence in 1991. At the same time, the investment climate still has to be improved. In particular, Kazakhstan 26 Kazakhstan: Costs of Unnecessary Bureaucratic Procedures and Delays, FIAS, 2001. Country reports on investment climate: Kazakhstan 127 Table III.18. Average time spent on regulatory and administrative processes in Kazakhstan Activity Entire sample Start-up Registration of the company 41 Licensing 29 Land use permits 26 Equipment certification 11 Subtotal 107 Operations Import operations 12 Export operations 8 Product certification 13 Dealing with tax officials 36 Subtotal 69 Source: Administrative and Regulatory Costs Survey, FIAS, 2001. has made excellent progress in developing a proper base for a functioning legal system. But a good existing written legislation is not enough, as effectiveness of the legal system depends on effective enforcement of the legislation. Private investors will not feel fully comfortable establishing and carrying out their business in Kazakhstan without a properly functioning judicial system to protect private property, enforce contracts, defend economic rights against infringement, and establish a secure environment for businessmen. From the perspective of private investors, the existing legal environment does not provide the sense of security needed to justify major investments in Kazakhstan. Confidence in the domestic legal system and in the implementation of new legislation generally remains low. Vagueness of laws, contradictory legal provisions and uncertainties in practical implementation translate into serious risks which many multinational investors would like to see minimized prior to committing to major capital investments. Many foreign companies cite the need to protect their investments from a never-ending barrage of decrees and legislative changes. Foreign investors have at times found that rules can change in the middle of an investment. Foreign investors also complain of inconsistency in interpretetation and implementation of laws and regulations, corruption, arbitrary tax inspections and unanticipated taxes, arbitrary treatment by customs officials, problems with closure on contracts, delays and irregular practices in licensing, land fees, etc. 128 Foreign direct investment in Central Asian and Caucasian economies: policies and issues One of the leading disadvantages, in addition to poor implementation of laws and regulations, is bureaucratic “red tape”. In the recent survey by FIAS, 73 per cent of enterprises in Kazakhstan were dissatisfied with the current state of the regulatory environment.27 On average, investors in Kazakhstan reported that about 23 per cent of management time is spent dealing with government regulations and administrative requirements, compared to only 4 per cent in several Latin American countries.28 Other concerns regarding investment implementation include the following: a. Transparency Transparency in the application of laws remains a major problem in Kazakhstan and an obstacle to expanded trade and investment. Foreign investors complain of moving goalposts and corruption. While foreign participation is generally welcomed, some foreign investors allege that the Government is not always evenhanded and sometimes reneges on its commitment. Foreign investment proposals are screened by government officials, sometimes at the highest level. The screening process itself is not a significant impediment to investment in terms of limiting competition or protecting domestic interests. However, the process is often non-transparent and can slow down investment decisions. Transparency of the legal system is hindered by often contradictory norms. While Kazakhstan has recently defined more clearly which laws take precedence in the event of a contradiction, it has become clear that stability clauses granted to investors under the Foreign Investment Law or other legislation will not necessarily be honoured when changes are made in the legal and tax regulatory regime. b. Tax administration The entire area of tax administration appears to be so problematic that it causes serious damage to the image of the country. Lack of transparent rules and regulations seemingly gives rise to a serious abuse of authority. Foreign investors feel they are subject to discretionary behaviour by the tax administration without any fair appeals mechanisms at their disposal to fight the alleged abuse. Inspectors appear to be driven by pressures on the tax inspectorate to generate additional budgetary resources or simply by the desire to benefit personally through bribes. Other local inspectors display similar behaviour. 27 Ibid. 28 World Business Environment Survey, World Bank, 2000. Country reports on investment climate: Kazakhstan 129 c. Corruption Inconsistent implementation and interpretation of laws and regulations can give rise to corruption. Corruption is encouraged by the gaps left by the legal system, the broad discretion given to civil servants and the relatively low wage levels in the public sector. With laws changing frequently, and implementing rules and regulations often enacted only with significant delays, civil servants and the private sector alike tend to be unsure and badly informed about the latest changes and the interpretation of laws in practice. Civil servants also treat investors differently, depending on their willingness to make “unofficial or facilitation payments”. These practices also seem to apply to the judiciary, resulting in inconsistencies even in the court system. According to the World Business Environment Survey, 63 per cent of investors ranked corruption as a serious obstacle to investment in Kazakhstan.29 The result of all this is that the private sector currently has no confidence or trust in Kazakhstan’s legal system, and has resigned itself to handling this continuous stream of inconsistencies and uncertainties through alternative means outside the formal process of law and administration. Many of the larger foreign investors try to obtain a more favourable decision through direct contacts with ministers or senior government officials whenever they encounter difficulties.30 In the World Business Environment Survey, 23.7 per cent of surveyed enterprises said they frequently pay bribes. In recent ratings by Transparency International in 2002 Kazakhstan ranks 88 among 102 countries included, indicating high levels of perceived corruption, slightly better than Azerbaijan, Indonesia and Nigeria and significantly worse than many others.31 Indeed, Kazakhstan presents a difficult business environment, so different from investor expectations and international practice that sectors apart from natural resources and utilities are currently perceived by investors as relatively unattractive. (c) Overall assessment of the policy and operational framework The principal findings of this review of the policy and operational framework are: 29 Ibid. 30 Kazakhstan: Costs of Unnecessary Bureaucratic Procedures and Delays, op cit. 31 World Business Environment Survey, World Bank, op. cit. 130 Foreign direct investment in Central Asian and Caucasian economies: policies and issues (i) In law, Kazakhstan has an open and liberal investment regime but in practice established investors, including major transnational and global companies, have had many problems in implementation of their projects. (ii) The foreign investment laws contain important assurances of protection and rights to the foreign investors. But a good existing written legislation is not enough, as the effectiveness of the country’s legal framework depends to an important extent on the effectiveness of existing enforcement mechanisms. From the perspective of private investors, the existing legal environment does not provide the sense of security needed to justify major investments in Kazakhstan. Confidence in the domestic legal system and particularly in the enforcement of legislation generally remains low. Vagueness of laws, contradictory legal provisions and uncertainties in practical implementation translate into serious risks which many investors would like to see minimized prior to committing to major capital investments. (iii) Clearly, Kazakhstan presents a difficult business environment. Major administrative obstacles to investment are inconsistent implementation and interpretation of laws and regulations, corruption and unofficial payments, bureaucratic “red tape”, insufficient institutional capacity of government agencies. These and other administrative barriers resulted in projects delays and increased transactions costs. (iv) Transparency in the application of laws remains a major problem in Kazakhstan and an obstacle to expanded trade and investment. While foreign participation is generally welcomed, some foreign investors allege that the Government is not always evenhanded and sometimes reneges on its commitment. Kazakhstan’s institutional governance is weak, further adding to the problems of transparency in commercial transactions. Potential conflicts of interests stemming from direct and indirect financial interests of government officials need to be addressed. (v) Kazakhstan is pursuing a policy geared towards the protection of domestic infant industries from foreign competition and the forging with State support of closer linkages between the large foreign investors in the resource sectors and domestic suppliers. The Government is keen on emphasizing increasing domestic content in investments, particularly in the oil and minerals sectors. At the same time, the Government has to take into account that these requirements forcing Country reports on investment climate: Kazakhstan 131 investors to buy goods and services preferably from local companies, may be challenged prior to Kazakhstan’s WTO accession negotiations since they appear to breach GATT and GATS rules and the TRIMs agreement. (vi) There are important issues which could undermine the attractiveness of Kazakhstan as a preferred location for prospective investors, including stability of legislation, particularly stability or sanctity of contracts, settlement of disputes, work permit quotas for expatriates, modality for determining world market prices under transfer pricing law, etc. (vii) When disputes develop between the interpretation of the conflicting laws, the judicial system, instead of helping, appears to add to the existing problem. Some investors indicated a low level of confidence in the ability of the courts to adjudicate disputes in a fair and equitable manner. According to foreign investors and legal experts, the courts frequently do not accept foreign court decisions. 3. Policy options and recommendations (a) Principal recommendations: a way forward Since gaining independence in 1991, Kazakhstan has attracted more than US$ 12 billion in foreign investment – more than all of the former Soviet republics, with the exception of the Russian Federation. The United States, which invested over US$ 2 billion in Kazakhstan during the past decade, is the country’s largest single source of FDI. However, over 80 per cent of all investment is in the extractive sectors. One of the lessons learned from Kazakhstan’s economic performance in the last decade is that the country needs to expand and deepen its economic reforms and diversify away from oil to protect its economy from external demand shocks. A key way to achieve these objectives is to remove current administrative barriers and offer opportunities for investment in the non-extractive sectors. Another important issue in creating necessary environment is to ensure implementation of structural reforms including transparency and corporate governance, privatization and commercialization of public utilities, and liberalization of trade policy. In order to guarantee regional competitiveness of Kazakhstan, the Government has to adopt better policies and procedures than its neighbours and thus differentiate 132 Foreign direct investment in Central Asian and Caucasian economies: policies and issues itself from its neighbours as the best place to do business in Central Asia. Kazakhstan is at the forefront in the region, namely in respect of reform of legislation with regard to commercial laws, in reform of the financial system, in pension reform, in maintaining macroeconomic stabilization and others. But there are still many areas where Kazakhstan is far from being the best and indeed has a poor reputation. This is particularly true in respect of administrative barriers. There is an opportunity to change this. (b) Recommendations for government action The principal recommendations for change in the policy and machinery of the Government to improve the FDI regime are set out in table III.19. They should be implemented in a manner which adopts at least the best practice in the Central Asian region. (c) Recommendations for subregional and regional cooperation Based on the findings and recommendations in this report a medium-term programme of technical assistance for Central Asian countries can be proposed. The main objective of the programme would be to promote economic cooperation among the five Central Asian countries through cooperation in investment attraction and promotion. Taking into account present needs of regional countries, as well as the low level of present economic cooperation in the region, main modules of the programme would be: (i) Coordination of national investment strategies of host countries; (ii) Removal of administrative barriers, improvement of business environment; (iii) Liberalization of trade policies including gradual removal of tariff and non-tariff barriers in the region, and establishment of free trade area; (iv) Joint capacity-building in specific investment promotion policies; (v) Joint coordination of investment policies of Central Asian countries with possible creation of common investment area in the region. ECE, ESCAP, UNCTAD, UNDP, IDB, and USAID could be proposed as potential donors. Taking into account that regional technical assistance programmes Country reports on investment climate: Kazakhstan 133 Table III.19. Kazakhstan: summary of recommendations Issue Key recommendations Phasing Legal Introduce the following modifications to existing ST/MT legislation: – on dispute settlement: ensure clear and unequivocal access to international arbitration. Work permits Simplify process for obtaining work permits for short-term MT foreign employees. Business Establish a centrally-coordinated business registration ST registration procedure and introduce an electronic database accessible to other ministries and the public. Tax Focus should be on particular priority taxation issues that ST administration pose serious problems to investors, including: (i) Increase transparency in tax regulations by interpreting critical cases and general terms of laws and regulations, and creating a functioning appeals mechanism; (ii) Strengthen enforcement of legislation and reduce the number of unnecessary audits and inspections. Customs (i) Reduce lengthy delays associated with transportation ST stoppages. (ii) Implement a comprehensive reorganization of customs MT in order to improve reporting and consultative relationships with other government agencies and private sector clients. Government (i) Identify clearly each agency’s area of responsibility MT bureaucracy and eliminate overlaps and duplications. (ii) Establish clear rules and regulations for conducting MT inspections and make them available to the public. Structural Improve transparency and corporate governance through full MT reform disclosure of ownership structures, stopping related party transactions and protection of minority shareholder rights. Institutional (i) Improve the institutional capacities of investment-related framework bodies taking into account the world-best practices. (ii) Enhance coordination between national and local agencies in implementing after-care services for investors. Regional Reduce trade barriers for cross-border trade and transit in the cooperation region and enhance cooperation within regional groupings. Note: ST = Short term, MT = Medium term. 134 Foreign direct investment in Central Asian and Caucasian economies: policies and issues in the area of trade and investment in Central Asia are planned and implemented by different donor organizations, a strategic partnership would be developed with other technical assistance providers to ensure synergy effects and tap the experience gained by other institutions in this field. Country reports on investment climate: Kazakhstan 135 Annex 1 The new law on investment in Kazakhstan After nearly three years of debate, the new Law on Investment in Kazakhstan entered into force on 8 January 2003 and replaced previous legislation, particularly the Law on Foreign Investment (1994) and the Law on State Support for Direct Investment (1997). The new Law stipulates that the terms of past government contracts with foreign companies signed before the entry of the new law into force will be protected against future legal changes until they expire. However, this protection will not be extended to new contracts. The above-mentioned stability clause has been thus substantially deteriorated. Another important issue for foreign investors is settlement of disputes. According to Article 9 of the new law, the settlement of disputes shall be carried out at Kazakh courts as well as at international arbitration courts to be determined by an agreement of parties. However, the wording of the previous investment law was more favourable and provided more confidence to foreign investors. Before, if investor chose international arbitration, in that case supposedly the consent of State would be received automatically. The new law is subject to interpretation as the conditions under which agreement is needed for the choice of international courts in case of dispute settlement are rather vague. Thus, on the basis of a brief review of these two important issues, it could be noted that protection of foreign investors by the previous investment law has been reduced.32 32 The author’s remarks are limited to these two issues, as owing to time constraints the new investment law was not analysed in full.
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