Openness to Foreign Investment
The declared policy of the government of Uzbekistan ("the government") is to attract foreign direct investment, but in reality, the government supports only those investments that are in line with its import-substitution, export-oriented industrialization policy. The government does not welcome investments in import-consuming sectors and discourages such investments by limiting access to foreign exchange; currency convertibility is cited by foreign firms as one of the greatest obstacles to normal investment operations. Existing legislation on its face grants foreign direct investors a host of incentives on a case-by-case basis, including tax holidays, duty-free import of capital goods, and protection against expropriation. However, the requirements for obtaining these benefits are ambiguous, the processes and procedures are cumbersome, and the regulatory environment is capricious. The lack of predictability deters many potential investors.
According to Uzbek law, the state must guarantee and protect the rights of foreign investors within the country. Primary legislation that guarantees foreign investment includes the following decrees: "On Foreign Investments," "On Guarantees and Measures of Protection of Foreign Investor's Rights," "On Guarantees of the Freedoms of Entrepreneurial Activity," and "On Production Sharing Agreements."
In principle, the judicial system upholds the sanctity of contracts. However, the judiciary is not independent and has favored state-owned or government-affiliated entities in commercial disputes.
The government's role in key industries can have discriminatory effects on foreign investors. The government plans to retain controlling shares of some key industries, including energy, telecommunications, airlines and mining. The government limits access to the raw cotton market, thereby exercising effective control of investments and capital flows. The government controls all silk sold in the country, and this dampens foreign investment in the textile and rug-weaving industries. This is not an exhaustive list. The government has announced plans to privatize some mid-sized and large state-owned companies and banks but has not yet done so. Moreover, a variety of challenges exists, including unrealistic valuations and the choice of which assets to retain.
In general, there are no limits on foreign ownership or control, except in the media, banking and insurance sectors, where foreign ownership is restricted. In banking, foreign investors are prohibited from legally operating except as joint venture partners with Uzbek firms, and foreign ownership of banks is limited to 50 percent. Banking and insurance firms with foreign participation are required to establish a charter capitalization fund of 5 million Euros, whereas the government determines the required size of the charter funds for Uzbek firms on a case-by-case basis.
There are two forms of registration for businesses with foreign investment: "enterprise with foreign investment" and "enterprise with foreign capital." Foreign investors act as shareholders in both cases; however, an enterprise with foreign investment has a special status and additional requirements, including:
-- Foreign investments must comprise at least 30 percent of shares of the charter fund of the enterprise;
-- Foreign investors, as a legal entity, must be among the participants in the enterprise; and
-- The minimum amount of charter capital of open and closed joint-stock companies must not be less than $400,000 for enterprises in the real sector. For other types of enterprises the minimum charter capital is 150,000 (except in the Republic of Karakalpakistan and in Khorezm province, where the requirement is $75,000).
Enterprises that meet the above requirements can be registered as "enterprises with foreign investment" by the Ministry of Justice of the Republic of Uzbekistan and enjoy some preferences, such as duty-free import of capital goods. Enterprises that do not meet the above requirements are subject to state registration at the offices of regional governors (hokimiyats) as ordinary (domestic) enterprises.
The government also uses licensing as a tool to regulate enterprises in several important sectors such as energy, telecommunications, retail sales, and tourism. Often licenses are issued by agencies that themselves directly participate in business operations in these sectors.
If the charter fund of an enterprise with foreign investment comprises $20 million or more, special government approval (usually in the form of a government resolution) is needed to register the enterprise. Frequently even smaller investments require permission from government authorities. Filing is mandatory.
The government closely scrutinizes investments, particularly those deemed to involve strategic national interests. The government does not have a standard and transparent screening mechanism, and the legislation is designed to protect domestic industries and limit competition from abroad. In some instances, screening has been used by the government to limit investment in certain industries and by certain countries.
The government reserves the right to cancel a business' registration. In some cases the government withdraws the business' license and begins lengthy inspections that lead to its subsequent closing.
Usually the Ministry of Justice registers a business and the relevant branch of the government makes the decision on licensing. According to the legislation the final decision on termination of an enterprise shall be issued by the Economic Court. Such decisions can be appealed in a Superior Economic Court in accordance with Economic Procedural Code or other applicable law of the Republic of Uzbekistan. Foreign investors are urged to have legal representation.
The main entity that reviews transactions for anti-competition concerns is the State Committee of the Republic of Uzbekistan on Demonopolization, Support of Competition, and Entrepreneurship. This is a state agency that implements state policy on developing a competitive environment, limiting monopolistic activities and regulating natural monopolies, reorganizing economically insufficient ventures, supporting the development of entrepreneurship, protecting consumer rights, and controlling advertising activities. The Committee performs these functions both directly and through its territorial units as well as through the Antimonopoly Policy Improvement Center.
The government requires screening of foreign investment in sectors of the economy that it determines are strategic, including mining, cotton processing, oil and gas refining, and transportation.
The following sectors are relatively more open to foreign direct investment (FDI): oil & gas exploration, extraction and processing; power (transportation and distribution, renewable energy); production of building materials, textile, machine building (automotive, agricultural, railroad trains and cars, aerospace, etc.); and tourism infrastructure.
According to Uzbek law, foreign investors and investments receive treatment equal to that afforded local investors in all sectors without exceptions.
Uzbekistan subscribes in principle to policies of institutional and economic reform, such as restructuring and privatization, in order to attract more foreign investment. However, implementation has been limited. The government's privatization program is promising, however many enterprises developed under the previous Soviet economic system need significant restructuring before they can be successfully privatized. The government to date has been unwilling to sell controlling interests in the most attractive enterprises and often has demanded prices far in excess of what investors would be ready to pay.
The main mechanism for selling state assets is open tender. In general, the tender process is transparent only at the initial stage. The government attracts local or international financial consultants for privatization of large enterprises. Only after the evaluation of an enterprise is completed are foreign investors invited to participate in the process. Many investors note a significant lack of transparency at the final stage of the bidding process, when the government begins conducting "direct negotiations" with the bidders before announcing the results of the tender. In some cases these "bidders" are in fact foreign mailbox companies that are associated with influential Uzbek families. While these mailbox companies may have a foreign address, their ties to the foreign country are tenuous.
There is no official discrimination policy against foreign investors at the time of the initial investment or after the investment is made. Certain incentives designated by presidential decree are granted on a case-by-case basis and are often disputed during the investment period. This issue is particularly acute in regards to tax incentives and registration requirements. Several foreign investors have noted conflicts between new legislation and a Presidential Decree on tax holiday time limits. Presidential Decrees are in practice easily overturned, and foreign companies have been detrimentally affected by the practice.
Foreign and local investors both suffer from government interference in investments, and bureaucratic obstacles consume significant time and resources. The current system of taxation is complicated and ambiguous. The taxation legislation makes offset of current losses impossible: a company that does not show a concrete profit for six months is considered bankrupt. The legislation also sets strict limits on deductions for marketing, communication and training expenses, and thus greatly inflates taxable income when compared with legislation in other countries. Corruption and rent seeking are endemic. A new Tax Code has been approved and entered into force January 1, 2008. Despite some decrease in tax rates and the allowance of deductions for certain expenses, the new code does not significantly alter the existing situation and does not address the issue of official corruption.
Foreign investment, participation, or control in private firms in the media sector is prohibited. According to the "Law on Mass Media" adopted on December 26, 1997, and updated in 2005, only Uzbek nationals can own a mass media enterprise. Joint ventures cannot apply for a mass media license or own/establish a mass media enterprise if the shares of the foreign investors exceed 30 percent.
Foreign ownership of private firms is, in principle, unrestricted, with the significant exception of firms in the media, tourism, banking and insurance sectors. However, the government often exerts influence over the operations of companies, even those where foreign investors own over 50 percent. In many privatized enterprises, the government retains a minority share of approximately 25 percent, and workers own another 25 percent, thus limiting effective control by outside investors.
With an estimated population of 27.9 million, Uzbekistan has all the ingredients needed to become a regional economic powerhouse: a dynamic, literate, and entrepreneurial population, the largest in Central Asia; relatively good infrastructure; and a large potential consumer market. Rich natural resources such as hydrocarbons, gold, and cotton offer potentially attractive opportunities for investors. (Uzbekistan is the world's second largest cotton exporter after the United States and, in 2008-09, the second largest producer of natural gas in the CIS.) However, the lack of macroeconomic and structural reforms has exacerbated bureaucratic inefficiencies and contributed to widespread corruption.
Businesses and investors suffer from a multitude of problems caused by government policies. In the past, enterprises with foreign investments enjoyed tax concessions and preferences, such as a reduced profit tax rate, grace periods, and exemption from customs duties on the property imported by foreign investors for their own production and personal needs. Foreign investors also are shielded for ten years from legislative changes that adversely affect existing investments. In July 2006, however, the government rescinded all existing, indefinite tax breaks for foreign companies, other than those with production-sharing agreements, such as oil and gas companies. This adversely affected a number of foreign businesses, mostly American and European, and some ceased operations. The 2006 legislation, which was retroactive, did not allow investors to claim damages.
Currency restrictions through the banking system hamper business and economic development, as do the government's restrictive trade policies. The government's manipulation and interference in the private sector leave companies unable to properly project profits and future capital purchases.
As shown in the following table, Uzbekistan consistently earns very low scores for corruption, economic freedom, and fiscal and trade policy. For example, Transparency International (TI) ranked Uzbekistan 174 out of 180 countries for corruption, Heritage Economic Freedom Index placed Uzbekistan 148 out of 183, and the World Bank's Doing Business index ranked Uzbekistan 150 out of 183.
|TI Corruption Index||Rank/score||2009||174/1.7|
|Heritage Economic Freedom||Rank/score||2009||148/50.5|
|World Bank Doing Business||Rank||2010||150|
|Millennium Challenge Corporation(MCC) Government Effectiveness||Score (%)||2007||58|
|MCC Rule of Law||Score (%)||2007||32|
|MCC Control of Corruption||Score (%)||2007||35|
|MCC Fiscal Policy||Score (%)||2007||75|
|MCC Trade Policy||Score (%)||2008||41|
|MCC Regulatory Quality||Score (%)||2007||11|
|MCC Business Start Up||Score (%)||2008||94|
|MCC Land Rights Access||Score (%)||n/a||n/a|
|MCC Natural Resource Mgmt||Score (%)||2008||73|
Conversion and Transfer Policies
Uzbekistan introduced currency convertibility in October 2003, but in practice access to foreign currency is still limited. Two legal exchange rates exist: the commercial (wire-transfer) rate and the exchange booth rate. All citizens have legal access to the exchange booth rate. Limitations to foreign exchange resulted in 2009 in average lag times of 2 - 4 months for current account convertibility for imports and slightly less for raw materials and components related to manufacturing. There is also a thriving black market exchange sector. As of December 2009, the black market rate of 2,100 Soum per U.S. dollar exceeded the official exchange booth rate of 1,520 by roughly 35 percent.
Although the government has committed to the provisions of the International Monetary Fund's Article VIII regarding currency convertibility for current account operations, in practice multiple informal restrictions remain in place. All legal entities must obtain permission from the Central Bank to purchase foreign currency, and applicants must expend significant time to navigate the bureaucracy.
The majority of foreign investors, regardless of nationality, report frequent difficulty obtaining sufficient foreign currency for operational requirements. The government reportedly issues banks confidential instructions detailing which orders are to be filled.
Investors experience delays of one to six months -- and sometimes as long as nine months -- when remitting profits, and during the interim the amount to be remitted is held by the Central Bank. These delays are at least in part a result of the government's tight fiscal and monetary policies -- the government runs a strict import substitution regime to control foreign trade and prevent capital outflow.
No legal, private, parallel market exists in Uzbekistan for investors to remit funds. Private money transfer businesses provide services only to individuals and have limits for foreign remittances. The government has phased out its previous system of import contract registration and replaced it with a regime of high tariffs and border closings in order to further promote a policy of import substitution. Border closings often cause delays in receipt of necessary production inputs.
Expropriation and Compensation
The government may seize foreign investor assets for violation of local legislation, breach of contract, failure to complete, as well as for arbitrary reasons such as reevaluation of assets, site or development programs, etc. Although the government can legally seize property with compensation at fair market value, it has expropriated property of joint ventures (with foreign investment partners) at lower than fair market value, usually in local currency only. The government has also inadequately compensated local businesses and individuals for seized property. Claimants can expect to expend considerable time and effort to have their claims heard.
In 2006-2007, the government targeted the two largest U.S. joint-ventures and attempted to push them out of the country and expropriate their assets. These two cases were eventually resolved, one through a negotiated settlement and the other through arbitration. In both cases, the U.S. partners relinquished their shares and left Uzbekistan.
Large, lucrative foreign businesses are more at risk for expropriation or similar action than others. Smaller companies are vulnerable to expropriation of land. Expropriation cases have been recorded in mining, telecommunication, machinery, and textile industries as well as in the retail trading sector. The greatest number of U.S. investor dispute cases has occurred in the trading, food processing, mining, telecommunications, gaming, and tourism sectors.
The "Law on Mass Media" issued on December 26, 1997, and updated in 2005, forces local ownership of mass media enterprises.
Some changes in legislation, especially regarding tax holidays and mandatory charter fund increases, have caused financial difficulties for existing foreign investors. Though this has not been construed as an attempt to expropriate investor holdings, it is a matter of concern.
Most disputes involve nonpayment or delayed payment for goods or services by state entities. Some disputes are complicated by the tax authorities, when they sequester funds from a company account before the court reviews the arguments of the company in the dispute. Disputes with joint venture partners, whether state-owned or private, are also common.
There have been a number of investment disputes involving foreign investors and contractors, particularly in the mining, textile, energy and trade sectors. The U.S. Embassy has noted several cases of non-payment, including one involving a U.S. construction contractor and one concerning a U.S. supplier of agro-chemical products. These disputes reflect a pattern of foreign investors and contractors relying too heavily on local partners and not thoroughly vetting them before developing the joint venture partnership. The local partners frequently cannot stand up to heavy government pressure or are simply corrupt.
Uzbekistan does not have a uniform, well-defined method of settling disputes or a legal system that fairly and consistently enforces property and contractual rights. The law "On Guarantees to Foreign Investors and Protection of their Rights" says that disputes associated with foreign investments (investment dispute) directly or indirectly, can be settled on agreement of the parties by consultation between them. The parties involved in an investment dispute can, on mutual agreement, determine the authority that will arbitrate the dispute. Foreign investors' disputes not associated with their investment activity on the territory of Uzbekistan are settled in accordance with the legislation of the Republic of Uzbekistan except for cases when a different procedure is provided for by an agreement in keeping with the rules of international law. Government officials inconsistently interpret laws and decrees, including the 1994 Law on Bankruptcy (revised in 2003), which often conflict with each other. Government interference in the court system is not unusual, as are accusations of corruption. Recently the government has admitted that the investment dispute resolution system needs to be improved.
Foreign investors have no reasonable expectation that the government will honor an international arbitration verdict in favor of the foreign plaintiff. The law "On Guarantees to Foreign Investors and Protection of their Rights" permits resolution of investment disputes in line with the rules and procedures of the international treaties Uzbekistan is a signatory of. However, in November 2006 the Constitutional Court of Uzbekistan discovered that this law does not stipulate the so-called consent of the involved parties -- that of Uzbekistan in this case -- to have their dispute settled at the international level. In other words, Uzbek justice is not going to recognize foreign businesses' attempts to defend their interests in international courts unless the written consent of all involved parties is provided.
Contractual provisions for international arbitration are insufficient. Domestic arbitration bodies in Uzbekistan are represented by Arbitration Courts; if international arbitration is permitted, the awards can be challenged in domestic courts. The Ministry of Justice is responsible for the resolution of all international commercial issues. Its power is limited and frequently co-opted by more influential powers within the government. A number of foreign companies have not received full payment, even after being awarded a judgment in international arbitration. (An example is Romak, a Swiss company with a U.S.-owned subsidiary that won its international arbitration case in 1997 but even now, over a decade later, has not received the $18 million awarded to it in the arbitration judgment.) Others have pursued a claim and won in the court system, only to have the government not enforce the ruling. There are several cases, however, in which international arbitration awards have been successfully enforced.
Uzbekistan is a member of the International Center for the Settlement of Investment Disputes and a signatory to the 1958 United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (The "New York" Convention). However, numerous companies have reported that the local courts, including the Tashkent Economic Court and the Supreme Court, have failed to enforce international judgments against Uzbek companies, particularly state-owned enterprises.
Uzbekistan has not yet notified the WTO on inconsistencies with Trade-Related Investment Measures (TRIMS) requirements. A provision of Presidential Decree No PP-1084 issued in January 2009 provides "Exemption from profit tax, single tax (for entities subject to the simplified system of taxation), property tax, and import duties for businesses that are qualified for localization projects." This exemption applies until January 1, 2012.
According to Uzbek legislation, requirements to use domestic products in manufacturing are to be applied uniformly. In practice, this is not always the case. For example, the government has granted some companies the advantages and incentives afforded under the localization program, even though they do not use local materials in production or assembly.
Tax incentives and privileges for foreign investors include tax exemption on property, income, and customs duties. The corporate income tax rate is 10 percent. Taxed profit can be reduced in accordance with the following:-- Investments to expand production through new construction or reconstruction of existing buildings and structures; repayment of credits issued for these purposes. (The tax deduction is up to thirty (30) percent of the taxed profit.);
-- 30 percent reduction in income (profit) tax if the company's exports account for 15 to 30 percent of the total sales of produced goods.
The following are exempted from the Value Added Tax (VAT):
-- Raw products, materials, and half-finished products imported for its own use by an enterprise with foreign investment that specializes in the manufacture of children's footwear.
When estimating the property tax for legal entities, the tax base shall be reduced by the cost of:
-- New production equipment for a period of five (5) years. (In case of sale or gratis transfer of the new equipment within three (3) years from the moment of its procurement, this privilege is annulled with the reinstatement of duties on the payment of income tax for the entire period over which the privilege had applied.)
Enterprises that export goods, works, or services -- with the exception of raw materials -- for foreign currency are granted:-- 50 percent reduction in property tax – if the company exports not less than 30% of the total amount of sales of the produced goods, works, or services;
Newly established production facilities are exempt from property tax for two years from the moment of registration. This incentive does not apply to enterprises created on the basis of manufacturing capacities and capital assets of liquidated (re-organized) enterprises or their separated divisions. Neither does it apply to legal entities created under existing enterprises or to production facilities that rent their property and equipment.
Enterprises can enjoy exemptions from customs duties for:
-- Equipment and spare parts imported in accordance with contracts that are included in a list approved by legislation. In case of sale or gratis transfer of the imported equipment within three (3) years from the moment of its procurement, this privilege is annulled with the reinstatement of duties on for the entire period over which the privilege had applied.
Joint ventures with foreign participation carrying out exploratory work in the oil and gas sectors have a seven year tax holiday from income tax beginning from the extraction start date. After seven years they enjoy a 50 percent reduction. They also are exempted from property and dividend taxes. Foreign partners in Production Sharing Agreements have to pay excise tax, profit tax, land tax, subsurface resource use tax, water tax, and social tax on the same basis as residents of Uzbekistan unless the terms of the agreement stipulate otherwise.
While there are no set pre-conditions for investing, companies must invest $400,000 in charter capital in joint-stock companies that operate in the real sector of the economy in order to qualify for certain incentives. For ventures in other sectors of the economy, the foreign investor must invest $150,000 to qualify for these incentives. In addition, a foreign investor must invest at least 30 percent in a business for the company to be legally considered a company with foreign investments.
Companies are encouraged to purchase products from local sources under the government's localization policy. This applies to both foreign and local investors; therefore, there is no national treatment problem under Article III GATT '94.
While there are no requirements that foreign equity be reduced over time, certain restrictions regulate foreign investments in the banking sector, where the foreign share cannot exceed 50 percent, and in the tourism sector, where it cannot exceed 49 percent.
Any sector that is not a priority industry for the Uzbek government should expect to have more difficulty importing capital and consumer products than a priority industry. Requirements affecting these industries are likely considered restricted information by the government and not applied uniformly.
Permission is not officially required to invest, though preference seems to be unofficially given to state-backed foreign firms and those that are closest to the decision-makers. There are incentives to attract foreign investments to less developed locations (mostly rural), but there are no requirements. In the banking sector, branches are not recognized as legal entities and therefore cannot provide banking services that utilize the capital of the parent company. Substitution for imports is covered under a localization program. Host country employees are required in some positions in banking and auditing companies: the chief accountant should be an Uzbek national, as should either the CEO or one member of the Board of Directors. In the tourism sector, only Uzbek nationals can be tour guides. There are no requirements for using only local sources of financing.
The government has introduced new requirements with the aim of increasing the financial stability of enterprises in the real sector of the economy. Beginning January 1, 2009, the minimum charter capital for new open and closed joint-stock companies will be $400,000. Existing open and closed joint-stock companies must increase their charter funds to $400,000 before January 1, 2010, or change their form of ownership. There are no regulatory requirements for foreign investors to disclose proprietary information. General legislation, such as the Civil Code (Chapter 64) and "Law on Monopolistic Activity" (Article 8), provides for general principles for the protection of commercial and trade secrets.
Participation of U.S. and other foreign firms in R&D is not regulated legislatively; therefore, there are no government restrictions.
Uzbekistan does not have any requirements that inhibit the mobility of foreign investors. Uzbekistan offers two types of non-tourist visas: a temporary business representative visa and a working visa. To apply, American citizens must submit documents regarding the company/business they are affiliated with to an Uzbek Embassy or Consulate. Foreigners working in Uzbekistan must register with the Ministry of Labor.
Uzbekistan does have export and import policies that negatively affect foreign investors. The government implements a strict import substitution policy to control foreign trade and limit capital outflow. There are high tariff barriers for most imported goods, as well as non-tariff barriers such as discriminatory excise tax rates. Some goods are banned for export, including grain and sugar. Import of ethyl spirit is prohibited.
Right to Private Ownership and Establishment
Uzbekistan's laws and decrees guarantee the right of foreign and domestic private entities to establish and own business enterprises and to engage in most forms of remunerative activity. The state reserves for itself the export of gold. Together, hydrocarbons, cotton, and gold exports generate most of Uzbekistan's foreign exchange earnings. (In the first nine months of 2009, hydrocarbons, cotton, and gold accounted for 39.3 percent, 7.3 percent, and 4.5 percent, respectively, of foreign earnings.) The government announced in a 2002 decree that it planned to scale back its monopoly of the cotton export trade and allow producers to sell 50 percent directly to buyers. To date, however, this change has not occurred. Foreign companies have entered both the cotton and hydrocarbon sectors.
Theoretically, private enterprises may freely establish, acquire, and dispose of equity interests in business enterprises. In practice, however, it can be difficult to do this, as securities markets are undeveloped.
Protection of Property Rights
Foreign entities may own buildings, but not land. The concept of property ownership exists and is respected by local and central authorities, as long as the government is not interested in owning that property. If the government or a well-connected entity decides it wants to own a piece of property, the original owner of the seized property should not expect to receive remuneration at market value. Each district Hokimiyat has a department responsible for management of commercial real estate and controls all activities relating to the sale and purchase of commercial real estate, from paperwork to asset valuations.
Uzbekistan's laws governing the acquisition and disposition of property pose relatively few problems for foreign investors, and are similar to laws in other CIS countries. Land in Uzbekistan is owned by the state. It can be leased, but it cannot be owned by private entities or individuals.
Uzbekistan is in the lower level Watch List of the U.S. Trade Representative's 2009 Special 301 Report due to the lack of significant progress on IPR issues and the failure of Uzbekistan to move forward with several IPR-related amendments. Recently, however, the government has gone ahead with potentially far-reaching IPR reform that includes new laws and regulations. Although pirated media are still sold freely on the streets, licensed video and audio disks have appeared for sale in Uzbekistan for the first time. The government has also indicated that it may soon accede to Article 18 of the Berne Convention regarding protection of pre-existing works.
Transparency of the Regulatory System
Ambiguous rules, legislation, and presidential decrees on foreign investor rights are often contradictory. On many occasions, local officials have interpreted laws in a manner that is detrimental to individual private investors and the business community at large. U.S. companies have complained that Uzbek laws are not interpreted or applied consistently. In addition, the government occasionally issues secret decrees or instructions that entities are required to comply with, despite having no knowledge of the order. Companies are particularly concerned with the consistent and fair application of the "Law on Foreign Investment," which outlines specific protections for foreign investors. Because of the prohibitive tax code and regulatory environment, foreign investors often seek tax incentives and relief from certain regulatory requirements through Cabinet of Ministers decrees, which are approved directly by the President. These, however, are easily revocable.
The new Tax Code introduced in 2008, like the old code, lacks important provisions found in most developed countries. For example, it does not allow credit for VAT on imports. The tax code makes no clear provisions on double taxation, and earnings of foreign-owned enterprises are therefore susceptible to double taxation. A double taxation treaty negotiated with the U.S. in 1994 has been ratified by Uzbekistan but not by the U.S. The law on labor unions says that labor union fees are voluntary, but in practice commercial courts often interpret these payments as compulsory and impose penalties on non-payers. The amount of money involved is not large, but the issue may be of concern to foreign companies with union policies. Strict rules on wages severely discriminate against foreign companies who follow the rules, whereas local firms often evade the laws by creating false employees.
Bureaucratic procedures, in particular licensing and financial reporting, are considered time-consuming and counterproductive. Government-owned banks, ministries, and agencies interfere in business operations and in some cases make efficient operations almost impossible. Documents required for licensing, registration and other permits are often amended without notice, which creates an opportunity for rent-seeking. As a result, documents are frequently rejected the first time they are submitted on the grounds of some technicality.
The government holds a monopoly on regulatory processes. However, influential actors in the "shadow economy" can create problems for foreign investors in certain sectors, such as oil and gas, telecommunications, real estate, mining, and automotive, by encouraging authorities to pressure foreign competitors.
Publishing drafts of laws and regulations for public comment is uncommon in Uzbekistan. Regulatory bodies often introduce changes and amendments to the commercial legislation without notification, which causes many disputes and misunderstandings, even among state institutions. In a few cases where legislation will be highly scrutinized by the private sector, certain well-placed foreign investors have had the opportunity to review and comment on upcoming legislation. However, these instances are extremely rare. There is often a considerable delay between the passing of a law and its full release and implementation. The government has been discussing the creation of a foreign investor council, which would provide an excellent opportunity to review draft laws on commercial issues. The Uzbekistan Chamber of Commerce and Industry has taken the lead in organizing discussions for investors and business people on issues of particular note as part of a larger forum.
Few of the local legal, regulatory, and accounting systems are transparent and consistent with international norms. For instance, local accounting standards and practice in some respects contradict internationally accepted standards. Although international advisors have tried to train accountants, local practice is still document and tax driven with an underdeveloped concept of accruals. As a result, financial reporting seldom accurately represents the financial position of Uzbek companies with foreign investments.
In principal there are no legal restrictions on foreign participation in industry standards-setting consortia or organizations, but there are some exceptions.
Efficient Capital Markets and Portfolio Investment
Although Uzbekistan has made some progress in financial sector reform, it is far from having an efficient market-oriented banking system and well-functioning commodity and capital markets. Financial sector reform has focused on creating an adequate legal and regulatory framework for financial intermediation and developing the sector's technical and institutional capacity. The result on paper is a developed legal foundation, stronger regulation and banking supervision, an internationally accepted set of accounting standards, an electronic payment system, and the creation of the Uzbek Commodity Exchange (UZEX). International accounting standards were adopted by banks in 1997, but most of them were not implemented because they do not comply with the Uzbek Tax Code and internal regulations of the Central Bank. Some government departments have implemented international accounting standards but have not updated their systems on a timely basis.
One of the major sources of irritation for firms operating in Uzbekistan is restricted access to cash. All inter-firm transactions must be conducted by bank transfer. Cash withdrawals by legal entities are only permitted for payment of wages and travel expenses. Cash receipts must be deposited on the same day they are received. A March 24, 2000, decree improved this situation somewhat by allowing individual entrepreneurs, some small enterprises, and joint ventures with foreign capital of $150,000 or more to withdraw cash from their bank accounts up to the amount deposited within the previous ninety days. However, later the government issued several new decrees instructing local administrations, commercial banks, and tax authorities to tighten control of cash circulation. There are stiff penalties for firms that fail to deposit their cash receipts in banks. Pervasive restrictions on cash withdrawals have resulted in many small enterprises conducting the bulk of their operations in cash, illegally. The situation is aggravated by the fact that the largest denomination bill is 1,000 Soum (about 45 U.S. cents), turning transactions of any significant value into logistical undertakings.
The authorities argue that in the absence of a developed inter-bank market, it is too early to switch to a market-based system of money and credit management. Foreign investors have access to local credit, although the terms and interest rates do not make it a competitive or realistic source of additional funds. The underdeveloped financial system, coupled with the rent-seeking found in the government sector, makes finding reliable credit terms very challenging.
The private sector has access to a limited variety of credit instruments. Businesses do not favor long and medium term loans due to high interest rates and demanding collateral requirements. Some groups of private businesses create credit unions, which also are used primarily as a source of short-term loans. Access to the credit instruments of foreign banks is limited and usually goes through local commercial banks. Commercial banks also use the credit lines of International Financial Institutions -- for example the Islamic Development Bank, the Islamic Corporation on Private Business Development, the Chinese Development Bank, Commerzbank, Dresdner Bank, Hypo Vereinsbank, and KfW -- to finance small and medium businesses.
In 2006 the Uzbek government facilitated the development of micro-crediting and created the Microcredit Bank; however, a few international banks speculate that the funds will not reach the intended recipients but instead will be appropriated by the well-connected elite. A number of U.S.-based NGOs funded by USAID (13 NGOs) have been active in the past in supplying micro-credit; however, these organizations have suspended their activities because the government has not issued implementing regulations to the new micro-credit law. The government forced several of these organizations to leave Uzbekistan in 2006 and effectively closed the operations of others through 2007. The EBRD, the IFC, and other international donors continue to explore possibilities for opening a micro-credit lending bank to help meet untapped credit needs.
Credit unions have become a popular source of short term credit for the private sector. In 2002, USAID together with the World Council of Credit Unions (WOCCU) launched a program to develop credit unions in Uzbekistan. The law permitting credit unions was issued in April 2002. USAID and WOCCU have since helped establish and strengthen nearly 50 credit unions in 13 regions of the country. By the end of 2009 more than 100 credit unions provided savings and loan services to their middle-income members.
In general the government welcomes portfolio investments, and many international fund management companies have worked in the country. Some of these specialized in investing in various sectors of the economy through stock markets (e.g., Tashkent Stock Exchange, or TSE); others invested in the real estate and construction sectors. In 2009 most portfolio investors left the market due to capital outflows caused by the Global Financial Crisis. At present the remaining portfolio managers are investing primarily in the insurance and leasing sectors.
The TSE hosts a low volume of equity and secondary market transactions. In most cases the State Property Committee (GKI) decides who can buy and sell shares and at what prices, as the government is involved in the majority of local joint-stock companies. It is often impossible to locate accurate financial reports for the local companies traded on the TSE.
The government declares that Uzbekistan has no problems with liquidity. By the end of 2009, foreign reserves exceeded $11 billion, which does not include $5 billion in the Reconstruction and Development Fund of Uzbekistan. The average liquidity ratio of local banks exceeds 45 percent, and in no case is it less than 30 percent. In 2008-2009 the government began increasing the capitalization of state-owned banks and encouraged private banks to do the same. The consolidated capital of commercial banks increased by more than 40 percent in 2009, but tough government control and overregulation of the financial sector make deposit and withdrawal of sizeable capital extremely difficult. The Central Bank of Uzbekistan controls all currency exchange operations, in effect implementing a selective conversion policy.
Total assets of Uzbekistan's commercial banks exceeded $10 billion in 2009, and consolidated capital reached almost $1.7 billion. The largest banks in the country are the state-owned National Bank for Foreign Economic Activity of Uzbekistan (NBU) and Asaka Bank. NBU controls most of the commercial bank loan portfolio and more than 50 percent of Uzbekistan's foreign-exchange business. According to the most recent publicly-available reports, NBU's assets totaled about $3.1 billion in October 2009; Asaka Bank's assets totaled $1.1 billion in July 2009.
Uzbekistan's financial sector still features certain archaic banking rules and underdeveloped capital markets. The banking system is in turn dominated by large state-owned banks and marked by a lack of openness and competition. Local banks perform a number of non-core functions, such as acting as tax controllers (withholding taxes and monitoring tax payments), registering export and import contracts and accounting for foreign trade operations, and accounting for settlements with creditors and debtors. Furthermore, the banking system remains the primary conduit for the government's directed credits to state-owned enterprises at negative real interest rates. The large portfolio of such credits poses a serious threat to the soundness of the banking system given the financial distress and un-profitability of most of these enterprises. Official information on non-performing assets is not publicly available, but we estimate that the percentage of non-performing loans in 2008 was probably less than 20 percent.
"Cross-shareholding" and "stable shareholder" arrangements are common in Uzbekistan, where the state or large private companies associated with influential Uzbek families frequently act as shareholders.
Competition from State-Owned Enterprises (SOEs)
Private enterprises in Uzbekistan cannot compete with public enterprises under the same terms and conditions. Businesses face more than the usual amount of bureaucratic hurdles if they compete with the government or government-controlled firms. Besides, most State-Owned Enterprises (SOEs) have monopoly advantages, which include better access to the local and external markets, smoother access to financing sources, and licensing privileges. For example, in 2004 the government granted exclusive control of the international telecommunication networks to the state-owned Uzbektelecom Company. This means that all providers of voice and data transmission services including Internet and IP-telephony can have access to long-distance/international channels only through Uzbektelecom. Accordingly, all financial settlements between local telecom operators and their international counteragents must be conducted through Uzbektelecom.
SOEs are active in key economic sectors including energy (power generation and transmission, oil and gas refining, transportation and distribution), metallurgy, mining (non-ferrous metals and uranium), telecommunications (fixed telephony and data transmission), agriculture (cotton processing), machinery (automotive industry, agricultural machinery, locomotive and aircraft production and repair) and transportation (airlines, railways).
Most SOEs in Uzbekistan are registered as national holding or joint-stock companies. Usually a minority share in these companies (less than 25 percent) belongs to their employees. Although SOEs have boards of directors, their senior executive managers report directly to relevant ministries or to the Cabinet of Ministers. The government is represented on SOE boards of directors by specially appointed government officials.
The Reconstruction and Development Fund of Uzbekistan (RDFU) was established in 2006 primarily for sterilization and accumulation of foreign exchange revenues, although officially it was presented as a financial institution for providing government-guaranteed loans and equity investments to strategic sectors. It was founded by Uzbekistan's Cabinet of Ministers, the Ministry of Finance, and the five largest state-owned banks. By the end of 2009, RDFU's equity capital had reached $5 billion. The fund provides debt financing for modernization projects in sectors that are strategically important to the Uzbek economy (e.g., energy, chemicals, and non-ferrous metallurgy).
SOEs and local financial institutions are required to submit their annual reports to the government, but at the same time they are not required by law to publish them. Local state-owned commercial banks are required to submit their books to independent audit.
Corporate Social Responsibility (CSR)
Corporate Social Responsibility (CSR) awareness is not a widespread phenomenon in Uzbekistan. However, many local companies are active in various charity activities.
In May 2005, armed militants stormed a prison in Andijon, released its prisoners, and then took control of the regional administration and other government buildings in Andijon Province. Fighting broke out between government forces and the militants, and reports indicated that several hundred civilians died in the ensuing violence. While there were no reports of U.S. citizens affected by these events, U.S. citizens and other foreigners in Uzbekistan frequently have experienced harassment from authorities and local residents since the 2005 violence, although the degree of harassment has lessened in 2008-2009.
Supporters of extremist groups such as the Islamic Movement of Uzbekistan (IMU), al-Qaida, and the Eastern Turkistan Islamic Movement remain active in Central Asia. These groups have expressed anti-U.S. sentiments. The al-Qaida linked "Islamic Jihad Group" claimed credit for the suicide bomb attack against the U.S. Embassy in July 2004. This group also claimed credit for terrorist attacks in late March and early April 2004 that killed 47 people in Tashkent and Bukhara. Most recently, a suicide bombing took place in Andijon in May 2009. In light of domestic and international threats, the government has implemented heightened security measures such as establishing security checkpoints, sharply restricting access to certain streets and buildings, and deporting nationals of suspect countries. On December 1, 2001, the Uzbek government imposed travel restrictions on large parts of the Surkhandarya province bordering Afghanistan, including the border city of Termez. Though the border between Uzbekistan and Afghanistan is officially open to traffic, in reality Uzbeks need permission from the National Security Service (NSS) to cross the border, and only select Afghans are allowed into Uzbekistan.
The State Department has issued several public notices specifically about the security situation in Uzbekistan, and all American citizens intending to invest in Uzbekistan should review the most current security information available via the State Department web site.
Uzbek law, including the Criminal Code, prohibits corruption. However, the existing legislation is not effective. For example, Uzbek law does not forbid government officials from acting as "consultants," a common method of extracting payment. Uzbekistan ranked 174 out of 180 countries in the 2009 Corruption Perceptions Index (CPI).
A number of officials have been prosecuted under anti-corruption laws. Despite these measures, there is considerable anecdotal evidence that officials, who have considerable latitude in interpreting regulations, supplement their salaries through bribes. Several major incidents of bribe solicitation have been reported to U.S. officials. Foreign investors who refuse to pay bribes have experienced difficulties.
Uzbekistan joined the UN Anticorruption Convention on July 27, 2008. Uzbekistan is not a signatory of the OECD Convention on Combating Bribery. Uzbekistan does not participate in any notable local or regional anti-corruption initiatives.
U.S. businesses have cited corruption as one of the main obstacles to foreign direct investment in Uzbekistan. Lack of transparency in bureaucratic processes, including tenders, and limited access to currency convertibility, encourage corruption.
Low income levels caused by the inefficient economy and lack of per-capita investments stimulate widespread corruption within government bodies and in almost all sectors of the economy, especially those where the government is involved. Bribery is commonly used to obtain lucrative positions, government contracts, preferences, lobbing, etc. Bribery is also used to escape from criminal prosecution. Citizens routinely have been required to pay bribes for facilitation of the most common services.
Bribery is considered a crime in Uzbekistan. Depending on the court verdict, punishment can vary from a penalty to a long term of imprisonment with confiscation of property. Often prosecutions tend to focus on political dissenters rather than on those who warrant punishment for their venality.
Government officials often express their support for toughening the fight against corruption, but no efficient measures have been taken so far. There are reports that senior government officials and their family members continue their practice of using state power for rent seeking or to gain financial rewards.
A bribe by a local company to a foreign official is considered as a criminal act in Uzbekistan. A local company cannot deduct a bribe to a foreign official from taxes.
Three main arms of the government are tasked with fighting corruption: the NSS, the Ministry of Internal Affairs (MVD), and the General Prosecutor's Office. Currently no international or local nongovernmental "watchdog" organizations have official permission to monitor the corruption situation in Uzbekistan.
Bilateral Investment Agreements
Uzbekistan has signed bilateral investment agreements with a total of 49 countries, including China, the Czech Republic, Egypt, Finland, France, Georgia, Germany, India, Indonesia, Israel, Italy, the Republic of Korea, Malaysia, the Netherlands, Poland, Saudi Arabia, Slovakia, Switzerland, Turkey, the United Kingdom, and the United States. Among these, several agreements, including those with Iran, Japan, and the United States, have not yet entered into force. In 2004, Uzbekistan and Russia signed a Strategic Framework Agreement that also includes free trade and investment concessions. Uzbekistan also has signed bilateral free trade agreements with 10 CIS countries (Russia, Belarus, Ukraine, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Turkmenistan, and Tajikistan). In November 2005, the government signed an alliance agreement with Russia, which provides for economic cooperation. Uzbekistan and Ukraine also agreed, in 2004, to remove all bilateral trade barriers. In 2006, Uzbekistan began the accession process to the Eurasian Economic Community (EURASEC), but later, in November 2008, suspended its membership in the organization.
The "Treaty between the government of the Republic of Uzbekistan and the government of the United States of America concerning the Encouragement and Reciprocal Protection of Investment" was signed in Washington, D.C., on December 16, 1994, and ratified soon after by the Uzbek Parliament. The U.S. government, however, has not acted to bring this agreement into force, and is unlikely to do so until the investment climate in Uzbekistan significantly improves. In 2004, Uzbekistan signed the regional Trade Investment Framework Agreement (TIFA) with the U.S. Trade Representative's Office and its four Central Asian neighbors. Annual meetings of the TIFA members feature active negotiations aimed at improving the investment climate in the region.
OPIC and Other Investment Insurance Programs
The Overseas Private Investment Corporation (OPIC) has been working in Uzbekistan since the signing of the bilateral investment incentive agreement in October 1992. Over the course of its operations in Uzbekistan, OPIC exposure has totaled $229 million for six projects. OPIC had no projects active in the country in FY2009. Uzbekistan is a member of the Multilateral Investment Guarantee Agency as a developing country.
The estimated annual exchange rate used in Uzbekistan varies from institution to institution. The exchange booth rate was 1 USD/1,520 Soum as of December 2009. The Soum is moderately depreciating by approximately 10 percent per year.
Labor market regulation in Uzbekistan is similar to that in the most of the former Soviet republics, with all rights guaranteed but some rights unobserved. Literacy is officially almost universal at 97 percent. Most local technical and managerial training, however, does not meet international business standards. Foreign firms report that younger Uzbeks are more flexible in adapting to changing international business practices but are also less well educated than their Soviet-trained elders. Corruption in the education sector has lowered educational standards due to the widespread practice of purchasing grades and even entrance to prestigious universities and lyceums. With the closure or downsizing of many businesses, it is easy to find qualified employees, and salaries are low by western standards. In the last nine years there has been a dramatic increase in the number of skilled workers migrating to Russia and Kazakhstan, among other countries, leaving less qualified workers at home to fill the gaps.
Payroll taxes are high. Employee income taxes, compulsory social security charges, and various other payments are collected and paid by employers and constitute nearly 50 percent of wages. Salary caps -- together with a taxation system that the government uses in an apparent attempt to prevent firms from circumventing cash withdrawal restrictions -- prevent many foreign firms from paying their workers as much as they would like.
In banking and auditing firms it is a requirement that key positions -- for example chief accountant, CEO, or member of the Board of Directors -- be occupied by host country nationals. In the tourism sector, only Uzbek nationals can be tour guides.
Several cases of workers striking were recorded in 2003 and 2004. After the May 2005 events in Andijon, however, there have been few large public displays of dissatisfaction. Widespread reliance on forced labor, including forced child labor, during the fall cotton harvest has generated international concern.
Foreign Trade Zones/Free Ports
The law on free economic zones passed on April 25, 1996, envisaged the establishment of free trade zones including consigned warehouses, free customs zones, and zones for the processing, packing, sorting, and storage of goods. In December 2008 the President of Uzbekistan issued a decree creating a free industrial and economic zone (FIEZ) in Navoi Province near the airport of Navoi City. The FIEZ was created for 30 years beginning in 2009 with possible further extensions. A special customs, foreign currency, and tax regime; a simplified procedure for entering, staying, and leaving; as well as provisions by which non-residents can receive a labor license will be in force in the territory of the FIEZ.
Businesses registered within the Navoi FIEZ are released from various taxes (on land, property, income, the improvement and development of the social infrastructure, unified tax [for small companies], and compulsory payments into the national road fund and the national secondary school fund), for different periods of time depending on the size of direct investment --
3 million < FDI (Euros) < 10 million --> 7 year exemption
10 million < FDI (Euros) < 30 million --> 10 year exemption
30 million < FDI (Euros) --> 15 year exemption
In the next five years after expiration of the tax holidays, the income tax and unified tax rates applied to these companies shall be 50 percent of the rates that are effective at that time in the rest of Uzbekistan. If the initial investment was above 30 million Euros, this period of "half rates" shall be extended to 10 years.
Foreign Direct Investment Statistics
Real statistics on foreign direct investments (FDI) are not available, and official figures are not always reliable. (For example, the government includes international loans and grants in its FDI figures.) According to official statistics, Uzbekistan projects $2.98 billion of foreign investment in 99 projects in 2010. This includes $2.42 billion of FDI in 62 projects and loans of $481.7 million in 37 projects under government guarantees. The largest amount of foreign investment will go to the fuel and energy sector ($2.28 billion, including $2 billion as FDIs). There are no statistics on Uzbekistan's direct investments abroad. Nor are there any reliable statistics on current FDI stocks and FDI inflows as a percentage of GDP. In 2009 Uzbekistan received about $1.8 billion in foreign investment, including $1.35 billion in FDIs.
From Uzbekistan's independence in 1991, U.S. firms have invested roughly $500 million in Uzbekistan. 2007 was a difficult year for many foreign investors, especially U.S. companies. Due to declining investor confidence and changes to Uzbek legislation, numerous international investors left the country or are considering leaving. Newmont Mining, the largest U.S. investor, and MCT Corp. (Coscom), a large cellular provider, both had extended difficulties with the government and left the country. Caterpillar Tractors pulled out in late 2006. Chevron-Texaco set up operations in 1992 and is focusing on producing lubricants for the Uzbek market. It remains in business in Uzbekistan but is experiencing difficulty.
One bright spot is General Motors Corporation, which set up a joint venture named GM Uzbekistan with Uzavtosanoat (Uzbek Association of Automotive Industries) to produce passenger cars under the Chevrolet brand in Asaka (Andijan Province). GM holds 25 percent plus one share in this joint venture. In December 2008 GM and Uzavtosanoat set up another joint venture named GM Power train Uzbekistan. By November 2011 the new company plans to build engine and casting plants in the Tashkent Province that will produce 360,000 car engines per year. GM owns 52 percent of the new venture, which is expected to employ 1200 people.
Other bright spots include Honeywell International, which in late 2009 signed a memorandum of understanding with Uzbekneftegaz, the Uzbek national holding company for oil and gas. Boeing has been a supplier of aircraft to Uzbekistan Airways for many years, and there is no reason to expect that this will not continue. General Electric, for its part, is expected to supply turbines for renovation of the Tashkent Power Plant; a Presidential program for modernization of the Uzbek electrical grid offers the prospect of even greater involvement by GE.
The list of large non-U.S. investors in Uzbekistan includes Zeromax LLC registered in Switzerland, Chinese CNPC, Malaysian PETRONAS, Swiss-owned Nestle, UK-owned British American Tobacco, and Russian-owned Gazprom, Lukoil, Beeline, and MTC. China currently is the largest source of foreign investment. Most foreign investors are operating in the oil and gas and telecommunications sectors. Many Western firms have had problems, including UK-based Oxus Gold and two Israeli companies. Shares or assets of these companies or their residual operations are routinely acquired by well-placed Uzbek insiders.