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2011 Investment Climate Statement - Uzbekistan


2011 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
March 2011
Report
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Openness To, and Restrictions Upon, Foreign Investment:

The government of Uzbekistan ("the government") declares that attracting foreign direct investments is a priority, but in reality it follows a very selective approach. The government generally welcomes investments that are in line with its import-substitution and export-oriented industrialization policy, and discourages investments in import-consuming sectors. In principle, existing legislation 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 often ambiguous, the processes and procedures cumbersome, and the regulatory environment capricious. The lack of transparency and predictability has deterred many potential investors.

Uzbek law provides a framework of rights and privileges for foreign investors, and calls upon the state to guarantee them. However, the legislation is ambiguous, contradictory and changeable. Some of these basic guaranteed rights, such as converting and repatriating profits and conducting business without government interference, are routinely violated by government actions. Difficulty in converting currency is cited by foreign firms as one of the greatest obstacles to normal investment operations.

In principle, the judicial system upholds investor rights and the sanctity of contracts, and foreign investors often retain independent local counsel. The judiciary is not independent, however, and has favored state-owned or government-affiliated entities in commercial disputes. There have been a number of cases in which foreign companies were not able to enforce contracts with local partners.

The government's involvement and control in key industries can also have discriminatory effects on foreign investors. The government maintains controlling shares of some key industries, including energy, telecommunications, airlines and mining, and controls investment and capital flows in the raw cotton market. The government also controls all silk sold in the country, dampening foreign investment in the textile and rug-weaving industries. Partial state ownership and influence are common in many sectors of the economy. The government has announced plans to privatize some mid-sized and large state-owned companies and banks but this has been slow to take hold. Privatization efforts often face a variety of problems, including unrealistic valuations and the choice of which assets to retain.

A foreign investor may participate in a variety of legal forms of business, from partnerships to joint-stock companies to wholly-owned enterprises. Businesses with foreign investment must register with both the Ministry of Justice and regional governor’s office (“Hokimiyat”). Depending on the extent of foreign participation, a business may be considered an “enterprise with foreign capital” (less that 30% foreign-owned) or receive special status as an “enterprise with foreign investment” (more than 30%, with a minimum charter capital). Foreign companies may also maintain a physical presence in Uzbekistan as “permanent establishments” without registering if they do not conduct commercial activities and only have representative functions. A permanent establishment does is not required to open a bank account or pay taxes.

There are several official limits on foreign investment. Foreign ownership and control are prohibited for airlines, railways, power generation, and other sectors deemed to be related to national security. Restrictions also apply to media, banking, insurance and tourism. Foreign investment in media enterprises is limited to 30 percent. In banking, foreign investors may operate only as joint venture partners with Uzbek firms, and banks with foreign participation face set charter funding requirements (10 million Euros for commercial banks, 5 million Euros for private banks) while the required size of the charter funds for Uzbek firms is set on a case-by-case basis. In the tourism sector, foreign ownership cannot exceed 49 percent.

The government closely scrutinizes all foreign investment, with special emphasis on sectors of the economy that it considers strategic, including mining, cotton processing, oil and gas refining, and transportation. There is no standard and transparent screening mechanism, and the legal framework is designed to protect domestic industries and limit competition from abroad. Screening can be used to limit investment in certain industries and by certain countries, depending on Uzbekistan’s current policy priorities.

The government also uses licensing as a tool to control enterprises in several important sectors such as energy, telecommunications, retail sales, and tourism. Often licenses for business operations in these sectors are issued by agencies that themselves have commercial interests in the sector.

A charter fund of an enterprise with foreign investment that comprises USD 20 million or more needs special government approval, usually in the form of a government resolution, to register the enterprise. Smaller investments in certain sectors of the economy also require permission from government authorities, although there is no official list of what these sectors are and enforcement is perceived to be random. In any case filing for a standard business license is mandatory.

The government reserves the right to cancel the registration of any business or withdraw its license. Lengthy government inspections may lead to punitive sanctions or subsequent closing. The Economic Court can decide to close an enterprise, and its decisions can be appealed in the Superior Economic Court. U.S. investors have characterized the process as unpredictable and non-transparent, making it a tool for forcible takeovers of businesses.

According to Uzbek law, foreign investors receive treatment equal to that afforded local investors in all sectors without exceptions. There is no requirement that Uzbek nationals own shares of businesses with foreign investments, or that the share of foreign equity be reduced over time.

Uzbekistan subscribes in principle to institutional and economic reform, such as restructuring and privatization, but implementation has been limited, reflecting an incremental approach to economic reform in place since the country’s independence from the Soviet Union in 1991. Many enterprises developed under the Soviet economic system need significant restructuring before they can be successfully privatized. The government to date has been unwilling to sell its controlling interest in the most attractive enterprises and often has demanded prices far in excess of what investors would be willing to pay.

The main mechanisms for selling state assets are open tender and auction. In general, the process is transparent only at the initial stage. The government uses local or international financial consultants for privatization of large enterprises, and only after they evaluate an enterprise are foreign investors invited to participate. 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. In some cases, the bidders are foreign-registered companies associated with influential Uzbek families, with a foreign address but tenuous ties to that country.

There is no official discrimination policy against foreign investors. Certain incentives designated by presidential decree are granted on a case-by-case basis and can be disputed during the investment period. This issue is particularly acute regarding tax incentives and registration requirements. Presidential decrees on tax holidays are in practice easily overturned, and foreign companies have been detrimentally affected by the practice.

Both foreign and local investors suffer from government interference in investments, and bureaucratic obstacles consume significant time and resources. The current system of taxation is complicated and ambiguous, leading to widespread corruption and rent seeking. Offset of current losses is not possible under current tax laws, and a company that does not show a concrete profit for six months is considered bankrupt. Uzbek law also sets strict limits on deductions for marketing, communication and training expenses, and thus greatly inflates taxable income when compared to legislation in other countries.

With the largest population in Central Asia, relatively good infrastructure, and rich natural resources such as hydrocarbons, gold, and cotton, Uzbekistan offers potentially attractive opportunities for investors. However, the lack of macroeconomic and structural reforms has exacerbated bureaucratic inefficiencies and contributed to widespread corruption. 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.

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, and foreign investors were shielded for ten years from legislative changes that adversely affected their 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 closed operations. The 2006 legislation, which was retroactive, did not allow investors to claim damages.

International surveys and rankings routinely assign Uzbekistan low scores for corruption and economic freedom. For example, Transparency International (TI) ranked Uzbekistan 172 out of 178 countries for corruption. Heritage Economic Freedom Index placed Uzbekistan 158 out of 183, and the World Bank’s Doing Business Index ranked Uzbekistan 150 out of 183.

Business Environment Indicators:
 

 

Measure

Year

Index/Ranking

TI Corruption Index

Score/Rank

2010

1.6 / 172

Heritage Economic Freedom

Score/Rank

2010

47.5 / 158

World Bank Doing Business

Rank

2010

150

Millennium Challenge Corporation (MCC) Government Effectiveness

Score/Percentile

FY2010

0.11 / 66%

MCC Rule of Law

Score/Percentile

FY2010

-0.29 / 24%

MCC Control of Corruption

Score/Percentile

FY2010

-0.30 / 26%

MCC Fiscal Policy

Score/ Percentile

FY2010

6.9 / 88%

MCC Trade Policy

Score/ Percentile

FY2010

65.1 / 37%

MCC Regulatory Quality

Score/ Percentile

FY2010

-0.78 / 13%

MCC Business Start Up

Score/ Percentile

FY2010

0.979 / 88%

MCC Land Rights Access

Score/ Percentile

FY2010

n/a

MCC Natural Resource Management

Score/ Percentile

FY2010

74.62 / 80%

Sources: http://www.transparency.org/policy_research/surveys_indices/cpi/2010/results
http://www.heritage.org/Index/Country/Uzbekistan
http://www.doingbusiness.org
http://www.mcc.gov/documents/scorecards/score-fy10-uzbekistan.pdf

Conversion and Transfer Policies

Uzbekistan introduced currency convertibility in October 2003, but in practice access to foreign currency is restricted. Two legal exchange rates exist: the commercial (wire-transfer) rate and the exchange booth rate, as well as an unofficial (black market) rate. All citizens have legal access to the exchange booth rate. Limitations to foreign exchange in 2010 resulted in severe lag times for current account convertibility for imports (three months to more than a year) and slightly less for raw materials and components related to manufacturing. These restrictions created the thriving currency black market. As of December 2010, the black market rate of 2,300 soum per U.S. dollar exceeded the official exchange booth rate of 1,635 by roughly 40 percent.

Under current law foreign investors are legally guaranteed transfer of funds in foreign currency to and from the Republic of Uzbekistan without any limitations, provided they have paid taxes and other obligatory payments. Foreign individuals may also freely transfer foreign currency out of Uzbekistan only if an equivalent amount of foreign currency was previously transferred into Uzbekistan.

In practice, however, the lack of currency convertibility is one of the greatest deterrents to foreign investment in Uzbekistan. Although the government has committed itself to the provisions of the International Monetary Fund's Article VIII regarding currency convertibility for current account operations, multiple informal restrictions remain in place. All legal entities must obtain permission from the Central Bank to access foreign currency, and applicants must expend significant time navigating 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 regarding which orders are to be filled.

Uzbek authorities may also stop the repatriation of a foreign investor’s funds in cases of insolvency and bankruptcy, criminal acts by the foreign investor, or when directed by arbitration or a court decision.

During these delays in converting and remitting profits, the amount to be remitted is held by the Central Bank. Currently there is no legal private market in Uzbekistan for investors to remit funds. Small, private exchange booths provide services only to individuals and have limits for transactions in foreign currency, leaving investors at the mercy of the Central Bank for hard currency. These conversion delays are at least in part a result of the government's tight fiscal and monetary policies and are intended to prevent capital outflow and dampen imports.

According to Uzbek law, 50 percent of foreign currency earned from exports must be exchanged for local currency through authorized banks at the official exchange rate. Exemptions to this requirement may be provided to some smaller companies or to majority foreign owned companies that export manufactured goods for not less than 60 percent of their total profit.

Expropriation and Compensation

The government may seize foreign investor assets for violation of local laws, breach of contract, failure to complete, or for such reasons as arbitrary reevaluation of assets and exercise of eminent domain. Although the government can legally seize property only with fair market compensation, it has expropriated property of local businesses and joint ventures with foreign investment partners at lower than market value. According to law, compensation for foreign partners must be made in a freely transferrable currency, but in most cases is given in local currency only.

Large, lucrative foreign businesses are more at risk for expropriation, but smaller companies are also vulnerable. U.S.-owned Newmont Mining and the telecommunications company MCT both faced pressure from the Uzbek government to sell their shares in joint ventures in 2006; both agreed to sell after lengthy legal disputes and have not returned to Uzbekistan. Historically, expropriations involving U.S. investors have occurred in the trading, food processing, mining, telecommunications, gaming, and tourism sectors. Local and non-U.S. foreign companies have also faced expropriation in the agriculture and retail sectors.

Inconsistent legislation and unpredictable changes in laws, especially regarding tax holidays and minimum charter capital, have caused financial difficulties for existing foreign investors. Though this has not been construed as an attempt to expropriate investor holdings, it could result in government takeover of businesses that cannot meet the shifting requirements. In 2010 the government seized a Russian food processing plant for inefficient implementation of the company’s investment commitments.

Dispute Settlement

There have been a number of investment disputes involving foreign investors and contractors in Uzbekistan over the past few years, mainly in the mining, textile, food processing and trade sectors. Most disputes have involved nonpayment or delayed payment for goods or services by state entities. Disputes within joint ventures are also common, as local partners must balance their commitments against heavy government pressure and corruption. Some disputes are further complicated by the tax authorities, who can seize assets or sequester funds from a company account before a court reviews the case.

Overall, Uzbekistan does not have a uniform, well-defined method of settling disputes. By law, foreign investors are entitled to use any international dispute settlement mechanism specified in their contracts and agreements with local partners. Dispute settlement processes are also included in some bilateral treaties, but there is currently no treaty covering U.S. citizens. If no international mechanism is specified, disputes are settled directly by the Economic Court of Uzbekistan. Separate arbitration courts are also available for civil cases, and their decisions can be appealed in the general court system.

Foreign investors should have no reasonable expectation that the government will honor an international arbitration verdict. The Constitutional Court of Uzbekistan ruled in 2006 that the written consent of all parties involved is required to recognize an international decision. Where the verdict is acknowledged, it can be appealed in Uzbekistan, so all disputes eventually end up in the Economic Court. Officials there, as in the rest of the legal system, inconsistently interpret the often conflicting laws and decrees on international investment. Government interference and corruption are common and should be expected.

When the Economic Court decides in favor of a foreign investor, the Ministry of Justice is responsible for enforcing the ruling. However, its authority is limited and frequently co-opted by more influential powers within the government. Judgments against state-owned enterprises are particularly difficult to enforce. There have been several cases, however, in which international arbitration awards were successfully collected. Monetary awards are usually made in local currency.

According to Uzbek bankruptcy law, foreign creditors can participate in liquidation or reorganization of a debtor only as part of a creditor’s committee.

Performance Requirements and Incentives

Uzbekistan is not a member of the World Trade Organization (WTO) and has several practices that do not conform to WTO requirements on Trade-Related Investment Measures (TRIMS). Many of these practices reflect Uzbekistan’s cornerstone import substitution policy, including tax breaks for exporters, non-tariff barriers for imports, and lack of efficiency in protecting intellectual property rights.

A Presidential Decree from January 2009 encourages manufacturing localization by offering qualifying businesses exemptions from many taxes and duties until 2012. By law, the requirements for using domestic products in manufacturing should apply equally to all companies, domestic and foreign. In practice this is not always the case, and the government has granted some companies the advantages and incentives afforded under the localization program even though they do not use local materials.

Current legislation provides a number of incentives for all foreign investment, including tax holidays and exceptions from custom duties. Incentives vary based on the sector and amount of investment. Foreign investors can also negotiate with the Cabinet of Ministers for special benefits, including additional tax and customs incentives, government guarantees and co-financing.

The current corporate income tax rate is 10 percent, with reductions granted for capital investment and export activity. Enterprises with more than 33 percent foreign ownership may import certain types of manufacturing equipment and technology free from customs duties and value added tax (VAT). Property taxes can also be reduced based on export activity.

There is no official discrimination policy that would create national treatment problems under Article III of the General Agreement on Tariffs and Trade (GATT). Although requirements are often not applied uniformly, this reflects the economic priorities of the government based on sector and applies equally to domestic firms.

Officially, no special permission is required to invest and there are few restrictions on foreign workers and financing. In banking and auditing companies, the chief accountant must be an Uzbek national, as should either the CEO or any one member of the Board of Directors. In the tourism sector, only Uzbek nationals can be tour guides. All foreign citizens, except those from some countries of the former Soviet Union, need visas to work in Uzbekistan and all individuals must register their residence with the authorities. Foreign workers must also register with the Ministry of Labor.

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, and the government maintains a monopoly on cotton exports. Natural gas, cotton and gold generate most of Uzbekistan's foreign exchange earnings. There are isolated cases of foreign companies who have, however, entered the natural gas and cotton production sectors and been successful.

In theory, private enterprises may freely establish, acquire, and dispose of equity interests in businesses. In practice, it can be difficult to do this as Uzbek securities markets are underdeveloped.

Protection of Property Rights

Both Uzbek and foreign entities may own buildings, but not land. Property ownership is generally respected by local and central authorities, although it can be subverted by the government or a well-connected business or individual. Each district government has a department responsible for managing commercial real estate, from asset valuations to sale and purchase.

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. All 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 (USTR)’s 2010 Special 301 Report due to the lack of significant progress on intellectual property rights (IPR). Uzbekistan is still not a member of the Geneva Phonograms Convention and thus does not provide any protection or rights for U.S. or other foreign sound recordings. It has also not acceded to Article 18 of the Berne Convention protecting pre-2005 foreign works, although there is legislation pending in the parliament to do so. The USTR noted that enforcement remains weak and criminal penalties for IPR violations are not sufficient to provide a deterrent effect. Uzbekistan is a consumer, but not a significant producer, of pirated material. Pirated audio and video material can be found in many stores and markets.

Transparency of the Regulatory System

The rules, legislation, and presidential decrees on foreign investor rights are often ambiguous and contradictory. U.S. companies report that local officials inconsistently interpret laws, often in a manner that is detrimental to individual private investors and the business community at large. In addition, the government occasionally issues secret decrees or instructions that businesses are required to comply with, despite having no knowledge of them. Companies are particularly concerned with the lack of consistent and fair application of the Law on Foreign Investment, which outlines specific protections for foreign investors. To avoid problems with the tax and regulatory measures, foreign investors often secure incentives through Cabinet of Ministers decrees, which are approved directly by the President. These, however, are easily revocable.

The Tax Code is particularly troubling for foreign investors, as it lacks important provisions found in most developed countries, such as credit for VAT on imports. It also makes no clear provisions on double taxation of earnings of foreign-owned enterprises. A bilateral double taxation treaty negotiated in 1994 was ratified by Uzbekistan but not by the U.S.

Bureaucratic procedures, particularly licensing and financial reporting, are time-consuming and often contradictory. Government-owned banks, ministries, and agencies routinely interfere in business operations. Requirements for licensing, registration and other permits are often amended without notice, which creates an opportunity for rent-seeking as documents can frequently be rejected on the grounds of a minor 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 trade, building materials, food processing, and textiles by encouraging authorities to pressure foreign competitors.

General knowledge of Uzbekistan’s legal system is low. Regulatory bodies often introduce changes and amendments to commercial legislation without notice, causing disputes and misunderstandings even among state institutions. Publishing drafts of laws and regulations for public comment is uncommon, but certain well-placed foreign investors may in rare cases have the opportunity to review and comment on drafts of legislation that will be highly scrutinized by the private sector. There is often a considerable delay between the passing of a law and its full release for public dissemination. 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.

Only a few of the local legal, regulatory, and accounting systems are transparent and consistent with international norms. Uzbekistan is gradually adopting international accounting practices, but some local regulations still contradict internationally accepted standards. Although international advisors have tried to train accountants, local practices are still document and tax-driven with an underdeveloped concept of accruals. As a result, financial reporting seldom accurately represents the financial position of companies in Uzbekistan. In principal there are few legal restrictions on foreign participation in industry standards-setting consortia or organizations.

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. 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 are being implemented slowly over time because they conflict with the Uzbek Tax Code and internal regulations of the Central Bank.

One of the major sources of difficulties for firms operating in Uzbekistan is restricted access to cash. All inter-firm transactions must be conducted by bank transfer, and cash withdrawals by legal entities are only permitted for payment of wages and travel expenses. All cash receipts must be deposited on the same day they are received. A decree in 2000 improved this situation somewhat by allowing individual entrepreneurs, some small enterprises, and joint ventures with foreign capital 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, but pervasive restrictions on cash withdrawals have prompted many small enterprises to conduct 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 60 U.S. cents at the official exchange rate), turning cash transactions of any significant value into major 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 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. The overregulated banking sector, burdened with a number of non-core controlling functions, corruption, and excessive bureaucracy, cannot meet the lending demands of its clients as efficiently as market-responsive institutions. Restrictions on cash movements also limit the resources flowing through the banking system, ultimately reducing the pool of funds available for small and medium business lending. Access to foreign banks is limited and usually goes through local commercial banks. Commercial banks also use credit lines from international financial institutions to finance small and medium businesses.

The government declares that Uzbekistan has no problems with liquidity. Foreign reserves for the end of 2010 are estimated at more than USD 12 billion, not including about USD 5 billion in the Reconstruction and Development Fund of Uzbekistan. The average liquidity ratio of local banks exceeds 45 percent, with no banks under 30 percent. In 2009 the government initiated an increase of capitalization in state-owned banks and encouraged private banks to do the same. Consolidated capital of commercial banks has increased by more than 40 percent in 2009-2010 and assets grew by more than 31 percent. However, tough government control and the overregulated financial sector make sizeable deposits and withdrawals extremely difficult. The Central Bank of Uzbekistan controls all currency exchange operations, and implements a selective conversion policy.

Total assets of Uzbekistan’s commercial banks in 2010 are expected to exceed 20.1 trillion soum (USD 12.4 billion), with consolidated capital exceeding 3.6 trillion soum (USD 2.2 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 latest publicly-available reports, NBU's assets totaled about 5.7 trillion soum (USD 3.5 billion) in July 2010, and Asaka Bank's assets totaled 2.45 trillion soum (USD 1.5 billion) in October 2010.

Uzbekistan's financial sector is still dominated by archaic banking rules, underdeveloped capital markets and large state-owned banks, and marked by a lack of openness and competition. Local banks perform a number of non-core functions, such as withholding taxes and monitoring tax payments, registering export and import contracts, and accounting for payments between creditors and debtors. Furthermore, the banking system remains the primary conduit for the government's directed loans to state-owned enterprises at negative real interest rates. In previous years, a large portfolio of such credits posed 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 publically available, but reliable independent consultants estimated that in 2001, 60 to 70 percent of bank loans were non-performing. However, due to stricter controls and a drop in the rate of loans issued, the percentage of non-performing loans in 2010 is estimated at 6 percent.

In 2006 the Uzbek government created its own micro-crediting institution, the Microcredit Bank. Although it was an important step toward development of micro-financing services, it is still a state owned and subsidized bank with a mandate of social objectives rather than market expediency. Low interest rates (5-7 percent per annum) regulated by the state and a limited resource base stimulate corruption and hidden arrangements between bank officers and borrowers. Low interest rates for deposit holders also hinder attraction of funds. The IFC and other international donors are exploring the possibility of opening a market-oriented micro-credit lending bank, but the projects have not been approved by the government of Uzbekistan. USAID has worked with the World Council of Credit Unions (WOCCU) to establish and strengthen to nearly 50 credit unions in 11 regions of the country.

Credit unions have become a popular source of short term credits for the private sector. As of May 2010, more than 100 credit unions in the country were working in Uzbekistan, offering high interest for deposits (3-4 times higher than in the banking sector) and charging reasonable rates for loans. In July, however, the Central Bank instructed credit unions to drop interest rates for deposits and loans to below the level of real devaluation of the national currency. This may drive private funds from the credit union sector.

In general the government welcomes portfolio investments, and many international fund management companies have worked in the country. Some specialized in investing through the Tashkent Stock Exchange (TSE), and others invested in real estate and construction. In 2009, most portfolio investors left the market due to the global financial crisis. At present portfolio managers invest mainly in the insurance and leasing sectors.

Currently 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.

"Cross-shareholding" and "stable shareholder" arrangements are common in Uzbekistan, with state enterprises or large private companies associated with influential Uzbek families frequently acting as shareholders.

Competition from State-Owned Enterprises

State-owned enterprises (SOEs) dominate those sectors of the economy recognized by the government as strategic, such as 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, locomotive and aircraft production and repair) and transportation (airlines, railways, municipal public transportation).

Private enterprises cannot compete with SOEs under the same terms and conditions. Most SOEs in Uzbekistan were created by simply renaming former government ministries or agencies, and so they have monopoly positions in key sectors of the economy and exercise delegated governmental powers. Private businesses face more than the usual amount of bureaucratic hurdles if they compete with the government or a government-controlled firm. Legislation also grants advantages to most SOEs, including better access to local and external markets, smoother access to financing sources, and privileges in licensing. SOEs are usually not subject to legislative budget constraints, unless they are in low-priority industries.

Some government measures limit private enterprise activity in the sectors in which SOEs operate. For example, in 2004 the government granted exclusive control of international telecommunication networks to the state-owned Uzbektelecom Company. All providers of voice and data transmission services, including internet and IP-telephony, (i.e., all of Uzbektelecom’s competitors) can access long-distance/international channels only through Uzbektelecom’s switches. All financial transactions between local telecom operators and their international partners must be conducted through Uzbektelecom, with Uzbektelecom’s approval. In some sectors, the government restricts private competition by limiting access to currency conversion.

Most SOEs in Uzbekistan are registered as national holding companies or joint-stock companies. Usually a minority share in these companies belongs to their employees or private enterprises. Although SOEs have boards of directors, one or more of the members will be a specially appointed government official and the senior executive managers report directly to the relevant ministries or to the Cabinet of Ministers. SOEs are required to consult with the government before making business decisions.

Uzbekistan’s Fund for Reconstruction and Development (FRD) was established in 2006 and has been used primarily for sterilization and accumulation of foreign exchange revenues, but officially it was presented as a financial institution for providing government-guaranteed loans and equity investments to strategic sectors of the domestic economy. It was established by Uzbekistan’s Cabinet of Ministers, Ministry of Finance and five largest state-owned banks. The equity capital of the fund reached USD 5 billion in 2010. The FRD provides debt financing for modernization and technical upgrade projects in sectors that are strategically important for the Uzbek economy (energy, chemicals, non-ferrous metallurgy, etc.). All loans require government approval. The credit portfolio of the FRD reached USD 871 million in 2010.

State-owned businesses and financial institutions are required to submit their annual reports to the government, but they are not required by law to publish them. Only state-owned commercial banks are required to undergo independent audits.

Corporate Social Responsibility

Corporate Social Responsibility (CSR) awareness is not a widespread phenomenon in Uzbekistan. However, many companies are active in various charity activities, either through their own initiative or at the direction of local governments.

Political Violence

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.

In May 2005, armed militants stormed a prison in the city of Andijon, released its prisoners, and then took control of the regional administration and other government buildings in the Andijon region. Fighting broke out between government forces and the militants, and reports indicate 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 experienced greater harassment from authorities and local residents in the following years. The degree of harassment has since lessened.

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. In 2004, the al-Qaida linked "Islamic Jihad Group" claimed credit for a suicide bomb attack against the U.S. Embassy and terrorist attacks in Tashkent and Bukhara that killed 47 people. In late May 2009, a small group of militants attacked a police check post near Khonobod in the Namangan region, injuring one police officer. On May 26, 2009, a suicide operative detonated explosives in central Andijon near a police station, killing at least one police officer and injuring several bystanders. In September 2009, there was a shoot-out in Tashkent between government authorities and suspected extremists that resulted in several deaths.

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. Continued instability in southern Kyrgyzstan following the 2010 political and ethnic violence have raised tensions and led to substantially increased controls at the Uzbek-Kyrgyz border. Although the border between Uzbekistan and Afghanistan is officially open to traffic, travel restrictions for the region remain in place. Uzbeks need permission from the National Security Service (NSS) to cross the border, and only select Afghans are allowed into Uzbekistan.

Corruption

Existing Uzbek legislation is not effective in curbing corruption, and U.S. businesses have cited corruption as one of the main obstacles to foreign direct investment in Uzbekistan. Uzbekistan ranks 172th out of 178 in Transparency International’s 2010 Corruption Perceptions Index.

Low wage levels caused by the inefficient economy 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, and exemptions from regulations. Bribery is also used to escape from criminal prosecution. Citizens are routinely required to pay bribes for facilitation of routine services.

A number of officials have been prosecuted under anti-corruption laws. Depending on the court verdict, punishment can vary from a fine to a long term of imprisonment with confiscation of property. Enforcement is arbitrary, and there is considerable anecdotal evidence that a large portion of officials use their latitude in interpreting regulations to extract bribes. Several major incidents of bribe solicitation have been reported to U.S. officials, and foreign investors who refuse to pay bribes have experienced difficulties.

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. Uzbekistan joined the UN Anticorruption Convention on July 27, 2008. Currently no international or local nongovernmental "watchdog" organizations have official permission to monitor corruption in Uzbekistan. Uzbekistan is not a signatory of the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, and does not participate in any notable local or regional anti-corruption initiatives.

Government officials often express their support for toughening the fight against corruption, but few effective measures have been taken so far and there are frequent reports that senior members of the government and their families continue to use abuse state power for rent seeking and financial gain.

There has been no substantial evidence to suggest that the government encourages or requires companies to establish internal codes of conduct that prohibit bribery of public officials. Only a few local companies created by or with foreign investors have effective internal ethics programs. Although paid routinely and considered a necessity to doing business, a bribe by a local company to a foreign official is considered a criminal act in Uzbekistan, and bribes cannot be deducted from taxes.

Bilateral Investment Agreements

Uzbekistan has signed bilateral investment agreements with a total of 49 countries. Several of these 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 11 CIS countries (Russia, Belarus, Ukraine, Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Turkmenistan and Tajikistan). In 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 in November 2008 suspended its membership in the organization.

A bilateral investment protection treaty 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. 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. The TIFA serves as a forum to encourage regional trade development in Central Asia.

OPIC and Other Investment Insurance Programs

The Overseas Private Investment Corporation (OPIC) has been working in Uzbekistan since the signing of a bilateral investment incentive agreement in October 1992. Over the course of its operations in Uzbekistan, OPIC exposure has totaled USD 229 million for six projects. OPIC had no new projects in the country in FY2010. Uzbekistan is also a member of the Multilateral Investment Guarantee Agency as a developing country.

Labor

Labor market regulation in Uzbekistan is similar to that in the most of the former Soviet republics, with many rights guaranteed to workers but often unobserved. With the closure or downsizing of many businesses, it is easy to find qualified employees and salaries are low by western standards. Literacy is officially almost universal at 97 percent, but most local technical and managerial training 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 educated than their Soviet-trained elders. Widespread corruption in the education sector has lowered educational standards as students purchase grades and even entrance to prestigious universities and lyceums. In the last ten years there has also been a dramatic increase in the number of workers emigrating to other countries, notably Russia, Korea and Kazakhstan, leaving less-qualified workers at home to fill the gaps.

Payroll taxes are high. Employee’s income taxes, compulsory social security charges and other contributions are collected and paid by employers. These mandatory payments and deductions can total almost 50 percent of a worker’s wage. Local regulations on wages often include salary caps.

Foreign Trade Zones/Free Trade Zones

The law on free economic zones, passed in 1996, envisaged the establishment of free trade zones including consigned warehouses, customs-free zones, and zones for the processing, packing, sorting, and storage of goods. In 2008 the President of Uzbekistan issued a decree creating a free industrial and economic zone (FIEZ) in Navoi region near the airport of Navoi City. The FIEZ was established for 30 years beginning in 2009 with possible further extensions. Businesses in the territory of the FIEZ are promised a special customs, currency, and tax regime; a simplified procedure for entering, staying, and leaving; and special provisions by which non-residents can receive labor licenses.

Under current legislation, businesses registered within the Navoi FIEZ are exempt from most taxes for 7-15 years, depending on the size of direct investment. For five years after the expiration of the tax holiday, the businesses’ income tax is cut by 50 percent. This extends to 10 years for large investments (over 30 million Euros).

Foreign Direct Investment Statistics

Accurate statistics on foreign direct investments (FDI) are not readily available. Official figures are not always reliable, and the government includes international loans and grants in FDI. According to official statistics, Uzbekistan projects USD 2.98 billion of foreign investment in 99 projects in 2010. This includes USD 2.42 billion of FDI in 62 projects and USD 481.7 million in loans under government guarantees for 37 projects. The largest amount of foreign investment goes to the fuel and energy sector (USD 2.28 billion, including USD 2 billion as FDI). There are no statistics on Uzbekistan's direct investments abroad. Neither are there any reliable statistics on current FDI stock and FDI inflows as a percentage of GDP. The IMF estimations that net non-debt creating capital inflows are at 2.5 percent of GDP for 2010 (2.6 percent of GDP in 2009). In 2009 Uzbekistan received about USD1.8 billion of foreign investment, including USD 1.35 billion of FDI.

Since Uzbekistan's independence in 1991, U.S. firms have invested roughly USD 500 million in Uzbekistan. Due to ongoing difficulties in the investment climate, numerous U.S. investors have left the country in the past few years or are considering leaving. Caterpillar withdrew in late 2006. Chevron-Texaco set up operations in Uzbekistan in 1992 and invested about USD 1.5 million in local production of lubricants for the Uzbek and regional markets, but is currently reducing its involvement in the joint venture.

Coca-Cola has been doing business in Uzbekistan since 1992 as part of Coca-Cola Bottlers Uzbekistan (CCBU). CCBU invested more than USD 140 million to build three state of the art production facilities (in Tashkent, Namangan, and Urgench) and launched production of soft drinks in 1993. A string of recent difficulties began with a criminal case against Coca-Cola’s joint venture partner, and after the case was settled in 2007 the business continued with a new partner owned by the hydrocarbon-oriented holding company Zeromax Group. When Zeromax Group was declared bankrupt in 2010, all of its assets were transferred to the Uzbek state oil and gas holding company.

Along with its 2007 acquisition of Daewoo, General Motors Corp. also inherited a joint venture between Daewoo and Uzavtosanoat (Uzbek Association of Automotive Industries) to produce passenger cars under the Chevrolet brand in Asaka, in Andijan region. GM holds 25 percent plus one share in the business. In December 2008, GM and Uzavtosanoat set up another joint venture, GM Power Train Uzbekistan, to build engine and casting plants in the Tashkent region starting in November 2011. GM owns 52 percent of the new venture, which is expected to employ 1,200 people.

AIG and the Uzbek Ministry of Finance formed the joint venture UzAIG in 1996. UzAIG provides insurance services but with a very limited exposure of around USD 2 million. In 2010, following the global financial crisis, UzAIG was reorganized and rebranded as Chartis and management of the joint venture moved to Kazakhstan.

The U.S. company Nukem Inc. has been working in Uzbekistan since 1992, selling uranium from Uzbekistan to the world market. Nukem was also active in the formation of the American-Uzbek Chamber of Commerce, non-profit organization established to promote commercial and cultural ties between the U.S. and Uzbekistan.

2010 was a difficult year for many foreign investors. A Russian-owned milk processing factory, Wimm-Bill-Dann (WBD) Company, was seized by Uzbek authorities in September. Criminal proceedings were launched against WBD executives on charges of non-fulfillment of investment commitments and violating tax and customs regulations. WBD believes that the case was a form of corporate raid or hostile takeover of their assets. A number of Korean and U.S. investors were al charged with tax violations during the year and their assets were frozen.

China and Russia are currently the largest sources of foreign investment, and most foreign investors operate in the oil, gas and telecommunications sectors. Other large foreign investors in Uzbekistan include: Chinese CNPC (USD 3 billion of total investments, including investment commitments), Malaysian PETRONAS (more than USD 500 million in total investments since 2006), Swiss-owned Nestle (about USD 20 million in total direct investments), UK-owned British American Tobacco (more than USD 300 million in total investments since 1994), Russian-owned companies Gazprom (more than USD 400 million in investments), Lukoil (about USD 200 million in total investments and USD 5 billion of investment commitments), VimpelCom (Beeline), and MTC (about USD 200 million in investments each).



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