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2011 Investment Climate Statement - Eritrea


2011 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
March 2011
Report
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Overview of Foreign Investment Climate

Eritrea remains a strict command economy, with government activities crowding out most private investment. Investors in Eritrea face significant risks, including: lack of transparency in the regulatory process, severe limits on the possession and exchange of foreign currency, lack of objective dispute settlement mechanisms, difficulty in obtaining licenses, large-scale use of conscripted labor, and expropriation of private assets. The Government of the State of Eritrea (GSE) uses the judicial system as a coercive tool to promote its own interests, making the courts a biased arbiter in legal disputes. These risks discourage domestic private investment not conducted under the GSE's auspices.

The potential exception to this trend appears to be the mining sector. Twenty-three small and mid-size mining and exploration companies have signed license agreements with the GSE, and many of them have already set up offices and begun exploring. The Canadian-based Nevsun Resources Inc. through the Bisha Mining Share Company was the first company to start producing gold at the Bisha Mine near the town of Barentu in January 2011. Representatives from the mining companies had been receiving preferential treatment, including easily approved travel permits, personal security details in the field, liberal import and export agreements, and easy access to government officials. Nonetheless, the GSE recently imposed arbitrary and capricious measures on this sector, such as restrictions on the number of Eritrean mining engineers who can work in the sector and being unwilling to issue travel permits starting in December 2010.

Measure

Year

Index/Ranking

TI Corruption Index

2010

2.6 (123 out of 178)

Heritage Economic Freedom

2010

176 out of 179

World Bank Doing Business

2011

180 out of 183

MCC Gov’t Effectiveness

2011

16%

MCC Rule of Law

2011

23%

MCC Control of Corruption

2011

89%

MCC Fiscal Policy

2011

0%

MCC Trade Policy

2011

53%

MCC Regulatory Quality

2011

6%

MCC Business Start Up

2011

31%

MCC Land Rights Access

2011

95%

MCC Natural Resource Mgmt

2011

25%

Conversion and Transfer Policies
The GSE places severe limits on the possession and exchange of foreign currency and lacks transparency in conversion and transfer policies. It is illegal for Eritrean citizens to hold or exchange foreign currency. As of December 2010, black market exchange centers approximately value the local currency or Nakfa at 45 to 1 USD, however currency exchange is illegal, even for foreigners, outside of a few government approved exchange locations, which exchange at a rate of 15 Nakfa to 1 USD. Companies have reported being unable to convert Nakfa to foreign currencies. For example, foreign air carriers have tens to hundreds of millions of unconvertible Nakfa in the bank. In addition, companies have reported that signed contracts allowing for the payment for certain services in Nakfa have been violated when the GSE would only accept payment in USD. There is currently a hard currency shortage in Eritrea which motivates the GSE to ask for payments in USD but provide income in Nakfa.

The GSE enacted a number of commercial laws purporting to allow for private enterprise, but these laws are not consistently implemented. The Foreign Financed Special Investments (FFSI) Proclamation issued in April 2007 established a framework for investments greater than $20 million. The proclamation's stated objectives are to achieve self-sustaining growth, facilitate the rapid expansion of exports, expand employment, and promote and protect foreign investment. The Eritrean Investment Proclamation issued in 1994 establishes a more general framework for investment. This proclamation's stated objectives are to encourage investment, expand exports, expand employment, and encourage the use of new technology. It also provides tax incentives for investors, as well as a framework for dispute resolution.

Proclamation 114 issued in August 2001 gives the Ministry of Trade and Industry the authority to negotiate the sale of public enterprises, but details of the process are unspecified. In practice, investors require approval from the Ministry regulating the specific project before investing, but there may also be other unpublished approval requirements. The Office of the President must approve all large-scale projects. The GSE has selectively and narrowly courted foreign investors to explore under-utilized resources, primarily in mineral extraction, but also in energy, fisheries, and tourism. Despite the investment proclamation's assurance against expropriation, the GSE has nationalized many foreign-owned businesses and other assets.

Expropriation and Compensation
The GSE has shown a pattern over many years of expropriating businesses without notice, explanation, compensation, or recourse. For example, in October 2008 the GSE abruptly terminated the Intercontinental Hotel Corporation's management contract for a government-owned hotel in Asmara. The hotel later reopened as a GSE-operated establishment. Legal provisions for such expropriations, other than eminent domain for public purposes, do not exist, and the GSE liberally interprets the idea of public purpose.

Dispute Settlement
Eritrea does not have neutral dispute mechanisms, although there are several unimplemented laws on the books regarding dispute settlement. Article 15 of Investment Proclamation No. 59/1994 provides a framework for investment dispute settlement and pledges the GSE to enter into bilateral and multilateral protection treaties. Foreign investors also have the option to resolve disputes through mechanisms specifically stipulated in investment agreements with the GSE, or through mechanisms created by multilateral treaties such as International Center for Settlement of Investment Disputes (ICSID). Eritrea has neither ratified nor signed the ISCID Convention, and there are no known cases in which the GSE accepted international arbitration for business disputes.

Performance Requirements/Incentives
Although laws and regulations provide for investment incentives, in reality the GSE provides them only rarely and on an ad hoc basis. The Customs Proclamation of 2000 Part X, provides for relief from duties and taxes for imports receiving value-added processing prior to export, but due to the lack of businesses operating in Eritrea, the Embassy is unaware of any businesses receiving such relief. The GSE restricts travel within Eritrea, requiring explicit written permission for foreigners with a minimum ten-day advance notice. The GSE frequently denies foreigners permission to travel, often by not replying to the application, and explanations are rarely given. Eritrea also has an opaque visa regime, and foreigners of many nationalities have reported difficulties obtaining entrance visas, including lengthy and unexplained delays. Eritrea is not a member of the WTO.

Right to Private Ownership and Establishment
The FFSI specifically limits foreign investment in financial services, domestic wholesale trade, domestic retail trade, and commission agencies, but permits investment in other sectors. The FFSI makes allowances for the remittance of net profits and has guarantees against nationalization or confiscation, except for public purposes and with due process of law. Investors should be aware, however, that most medium-to-large businesses in Eritrea are controlled by either the GSE or the ruling party, the People's Front for Democracy and Justice (PFDJ). In 2005, the GSE suspended all private construction activity, leaving only those owned by the GSE or PFDJ in operation.

Protection of Property Rights
Eritrea's civil law protects private property, but the GSE has a history of expropriating houses, businesses, and other private property without notice, explanation, or compensation. Trademarks, patents, and copyrights are available through a procedure involving a public advertisement in the local press, but Eritrea is not a party to any international conventions on intellectual property rights.

Transparency of the Regulatory System
Eritrea has not convened a parliament for over a decade, and all laws are issued by proclamation from the executive branch. The GSE also does not operate a clearly organized regulatory system; what procedures are in place appear to be of haphazard creation and irregularly enforced. The GSE often does not announce new regulations prior to implementation, and they are often unequal in application and subject to sudden change. The law school only recently reopened in the fall of 2010 after being closed for 3 years and no new law licenses are being issued. The constitution was ratified in 1997 but has not yet been implemented. In addition, the GSE neither publishes accounts of its decision making process nor offers a public comment period for proposed laws or regulations. Local business owners report extensive difficulties with obtaining import and export licenses, customs clearances, telephone and mobile phone lines, land leases, and work permits. The central and regional governments often do not coordinate policies and procedures, adding to the opacity of conducting business outside of Asmara. The International Monetary Fund (IMF) reported investor confidence is undermined by the state's growing role in commercial activities and the lack of a transparent regulatory environment.

Efficient Capital Markets and Portfolio Investment
Eritrea has neither a stock exchange nor a stock market, and the state owns all financial institutions. Although the IMF states that the banks have a high proportion of non-performing loans, the banks may be profitable due to income from foreign currency transactions. The GSE's complete control of foreign exchange makes repatriation of profits difficult or impossible.

Competition from State-Owned Enterprises (SOEs)

The GSE claims that the border conflict with Ethiopia has interfered with Eritrea’s transition from a centrally planned economy to a market-based economy through the privatization of formerly state-owned enterprises and the liberalization of investment and trade.

At independence, part of the Eritrea’s economic reform was to create a development strategy based in self-reliance as well as integration into the world market. The government began to privatize state-owned enterprises, but the ruling party continued to espouse the importance of state investment in business and industry to balance out regional disparities. In reality, the party steadily became more involved in business, buying and expropriating almost every large enterprise in the country. The GSE pressures the remaining private enterprises with high taxes and import duties. For example, the tax rate on profits of more than 42,000 Nakfa ($2804) of incorporated businesses is 30 percent.

Private business activities are restricted and foreign investment is discouraged. The role of industrial production decreased due to shortage of raw material, affecting private and government owned enterprises. Both the military and the PFDJ used national service conscripts as a low-cost labor force, disrupting free competition in the labor market. National service in the military is mandatory and open-ended for all Eritreans. The ruling PFDJ and the military have continued to serve as an economic oligopoly which controls trade and production. There is no free capital market in the country.

Corporate Social Responsibility (CSR)

There is little, if any, awareness or concern for corporate social responsibility among enterprises operating in Eritrea. There are no known entities that adhere to OECD Guidelines for Multinational Enterprises. At least one foreign company negotiated an exemption from using National Service labor.

Political Violence
The threat from domestic insurrection, civil disturbances, and political violence is low, although there are reports of opposition movements operating in remote areas. Eritrea's border with Ethiopia is tense due to unresolved border issues. The border with Djibouti is also tense due to a military conflict in 2008. Settlement on that dispute is currently being mediated.

Corruption
Eritrea has historically been known as a country with low corruption, but there are indications that corruption does exist. Civil court cases are often directly influenced by the Office of the President, or by former fighters obtaining decisions in their favor (fighters, soldiers from the struggle for independence, have high social standing and considerable influence within the GSE). High ranking military officials have also been known to confiscate houses and other property. The GSE controls all foreign exchange, making it virtually the only legal source of imports and creating illicit profit opportunities for smugglers (who are often high-ranking Eritrean military officers). Eritrea is not known to be a party to any international anti-corruption agreements.

Bilateral Investment Agreements
Eritrea's only known bilateral investment agreement is with Italy, although it is possible that unpublished investment agreements also exist with Qatar, the U.A.E, Saudi Arabia, Libya, Iran, and/or China.

OPIC and Other Investment Insurance Programs
OPIC programs do not currently operate in Eritrea. Due to the poor state of bilateral relations and the lack of bilateral trade, the GSE has little interest in such an arrangement.

Labor
Eritrea has a large supply of semi-skilled laborers due to high levels of unemployment. Technical experts, highly skilled professionals, and managers are in short supply. Many of the highest skilled workers have left Eritrea due to deteriorating economic conditions. Eritrea is not a signatory of the ILO, although purporting to uphold many of its provisions. As much as one-third of Eritrea's workforce is conscripted into national service, in which there is no defined term of service. The GSE forces national service employees to work indefinitely in specific jobs with no job mobility, in which they are paid well below the national minimum wage.

Foreign Trade Zones/Free Ports
The GSE constructed a free trade zone in Eritrea's port city of Massawa in 2001, and promised to issue the first licenses in 2006, but no companies are known to operate in the zone. The GSE continues to promise the imminent issuance of more licenses, but it has yet to follow through. Proclamation 115 issued in August 2001 declares that in the zone there will be: 1) no taxes on income, profits, or dividends; 2) no customs duties on imports; 3) no currency convertibility restrictions; 4) no minimum investment; 5) 100 percent foreign ownership; and 6) 100 percent repatriation on profits and capital. There is at least one foreign company that shows readiness to invest in the free zone. The free zone authorities claim that at least 14 other companies, local and foreign, will follow suit. Significant smuggling occurs at the border with Sudan. Eritrea receives considerable imports via land route from Sudan.

Foreign Direct Investment Statistics
Data on foreign direct investment (FDI) is not available from the Bank of Eritrea. Although the Investment Proclamation of 1994 governs all foreign investment, it contains no specific definition of FDI. The UN Conference on Trade and Development (UNCTD) 2008 FDI report states Eritrea had $3 million in FDI inward flows and $380 million in FDI stock (accumulated inflows) in 2007, the most recent year for which data is available. No data is available on outflows. FDI in the mining sector increased substantially in 2009, as Nevsun's Bisha mining project prepared for ore extraction that began in January 2011. It is unlikely, however, the GSE will see profits until 2012, since the initial profits will be used to recoup Nevsun's investment costs. Eritrea is one of a few countries in the world that does not publish national account, trade, and budget figures.



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