C. Kazakhstan by kpn40237

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									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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