BISNIS - Uzbekistan Report

JULY 95

BISNIS

Economic and Trade Overview of UZBEKISTAN - July

Geography:

Slightly larger than California with 447,000 square kilometers of territory, Uzbekistan shares borders with all the other Central Asia states and is at the center of the region's transportation and power systems. About three-fifths of Uzbekistan's land area is desert steppe broken by irrigated, fertile oases along the banks of two great rivers, the Amu Darya and Syr Darya. Uzbekistan has cold winters and no more than 8 inches of rainfall a year, but its hot, dry summers, extending from May through October, and water for irrigation, create excellent growing conditions for warm weather crops such as cotton, tobacco, fruits, and vegetables.

Tashkent is the country's capital and is located in the northeast corner of the country in the foothills of the Tien Shan Mountains. The capital region is home to 4 million people and has the country's most advanced manufacturing, nonferrous metallurgy, and energy processing industries. Tashkent also is home to Uzbekistan's principal educational and cultural institutions and a highly educated population that is a least a third European. The fertile Ferghana Valley, the odd shaped tail projecting to the east from the main body of the country, boasts six million people, including large minorities of ethnic Kyrgyz, Tajiks and Russians. The Ferghana Valley extends into parts of Tajikistan and The Kygyz Republic, and those parts are economically integrated with Uzbekistan and have large Uzbek minorities. The Ferghana produces the major share of the country's cotton crop and also contains manufacturing plants and oil and gas fields. Uzbekistan's central region consists mostly of desert, broken by the Oases of the Zarafshan River, Qarshi Steppe, and Sukhandarya River and contains the ancient "silk road" cities of Bukhara and Samarkand and the mining center of Navoi. The central region produces cotton and contains Uzbekistan's gold mines, textile factories and the largest gas and oil fields. Far to the west lie the ecologically damaged Aral Sea delta and the vast deserts which characterize the Karakalpak Autonomous Republic. Overuse of the rivers which feed the sea has already reduced it to two-thirds its former size, and salinization of the area around the sea threatens the viability of a region in which a million people live. Finally, blowing sand and salt from the now dry lake bed threaten to turn areas far downwind into deserts.

Population:

Uzbekistan's 22.2 million people are 71.4% Uzbek, 8.3% Russian and other Europeans, 4.7% percent Tajik, 4.1% percent Kazakh, 2.4% Tatar and 2.1% Karakalpak. Uzbek is the official language and is the native tongue of 75 percent of the population, 5 percent speak Tajik, and 14 percent are Russian speaking nationalities. About one-third of the population speaks Russian. Before the post independence emigration of Europeans and peoples such as the Crimean Tatars, Uzbekistan's population was growing 2.6 percent a year, one of the higher rates in the world. As of 1993, over 40 percent of the population was under 15 years old. Tashkent with 2.1 million people is the largest city in Central Asia, but the total population is 61 percent rural. Although the official unemployment rate is negligible, there is considerable hidden unemployment and underemployment, particularly in rural areas.

Political Developments:

The Republic of Uzbekistan proclaimed its independence on August 31, 1991 and was recognized by the United States on December 25, 1991. Uzbekistan is a member of the United Nations and the Commonwealth of Independent States (CIS). Islam Karimov, was first elected President by Uzbekistan's Supreme Soviet in 1990 and later won a popular election in 1991, eventually taking the leading post in the ruling National Democratic Party (NDP) as well. On March 26, 1995 Karimov held a nationwide referendum to extend his presidential term until the year 2000 and subsequently claimed the support of 99% of the population. Professing allegiance to what he terms "eastern democracy", Karimov has stressed the importance of political stability over Western-style democratic reforms. Though officially a multiparty system, the principal opposition parties including the Erk (Freedom) Democratic Party, the Birlik (Unity) People's Movement (BPM) and the Islamic Rebirth Party (IRP) have been banned, leaving the NDP and the pro-government Homeland Progress Party (HPP) to control the Oliy Majlis or parliament.

Economic Overview:

Uzbekistan is the most populous Central Asian state, and its transportation connections, though still inadequate, are the best in the region. Although 61 percent of the people live in the countryside and its industrial sector is proportionally low, Uzbekistan has a highly educated work force boasting a nearly 100% literacy rate and the region's largest manufacturing base in absolute terms. The Government is actively working to encourage private economic activity and open the way for creation of a market economy.

Agriculture and the related agro-industrial sector contribute some 40-50 percent to Uzbekistan's economy. The relative stability of Uzbekistan's agricultural performance since the dissolution of the Soviet Union has proved a primary underpinning for the country's economic development. Uzbekistan is the world's fourth largest producer of cotton and also produces significant amounts of silk, fruits, and vegetables for export. Grain and animal husbandry are also major activities though 75 percent of grain and a large portion of meat must be imported. Cotton, which accounts for 40 percent of agricultural production and 80 percent of exports, is a central government concern. With a projected annual harvest of approximately 4 million tons, Makhalli sanoat, the Government-controlled cotton enterprise is positioning itself to take advantage of unusually high world prices for raw cotton. Makhalli sanoat has also entered into a joint venture with a Swiss firm to develop its milling capacity which currently extends to only 15% of its harvest. These developments are balanced against a previous Government policy of reducing acreage sown to cotton because of the ecological damage and dependence on food imports that have accompanied excessive reliance on this crop. Since 1980 the area sown to cotton has dropped from 1.9 million to 1.5 million hectares, though cotton cultivation is now expected to stabilize at this level.

Uzbekistan's nonferrous metals, particularly gold, already make a strong contribution to its export earnings. Currently producing approximately 70 tons of gold per year, Uzbekistan is the seventh largest producer in the world and contains the world's fourth largest reserves. In 1992, the Uzbekistan Government entered into a joint venture with the U.S.-based Newmont Mining Company to produce an estimated 5 million ounces of gold over the next 17 years. Uzbekistan also controls 8% of the world's annual uranium production is a significant copper producer and has sizable reserves of zinc, lead, silver, wolframite and tungsten.

Uzbekistan also possesses substantial hydrocarbon resources, ranking fourth among the NIS states and among the top 10 global producers. Most notable among Uzbekistan's oil and gas fields are the giant Mingbulak and Kokdumalak fields currently yielding approximately 43 billion cubic meters of natural gas. In January 1995, M.W. Kellogg, a subsidiary of Dresser Industries concluded an agreement with the state oil company Uzbekneftegaz for the construction of a $125 million natural gas recompression condensate facility at the Kokdumalak field. This will enable Uzbekistan to produce an estimated 2.5 million metric tons of condensate per year providing further impetus to an expansion in energy production which in 1994 already provided for 50% of domestic needs.

Uzbekistan's manufacturing sector is focused on agriculturally related products such as cotton farming and processing machinery, irrigation equipment, textile machinery, and fertilizers. The Chkalov aircraft plant in Tashkent is also a major NIS producer of the Il-76 civilian aircraft in addition to components for military transports, tankers and other aircraft.

Macroeconomic Performance:

Uzbekistan's natural resources and relatively low level of industrialization have helped it avoid many of the severe economic disruptions that have afflicted other states of the former Soviet Union. The Gross Domestic Product (GDP)of Uzbekistan suffered only a moderate cumulative decline of 10 -15% over the last five years, compared to 30-50% GDP declines in Ukraine and Russia. According to official statistics announced in March 1995, Uzbekistan's GDP in 1994 fell only 3.5% compared with an average drop of 20% in other CIS states. Moreover, the same statistics contrast a 2% fall in industrial production from 1991 to 1994 with a CIS average drop of 40%. Food production since the dissolution of the Soviet Union has similarly fallen the least of any NIS state, though the Government has still had to rely on foreign imports. Unemployment is also quite low with official estimates at less than 1%.

A major determining factor in Uzbekistan's economic stability has been its ability, unlike any other NIS state, to increase its domestic oil production in the face of Russia's moves to bring its prices to world market levels. Uzbekistan's exports of cotton and gold on world markets have also provided a stabilizing influence. The current high price of cotton on the world market should provide for continued stability in this respect.

Economic Reform Program:

Soon after declaring Uzbekistan independent, Uzbekistan's Government established policies that were unequivocally opposed to the "shock therapy" approach to economic reform. The initial emphasis was on supporting inefficient state enterprises and shielding consumers from inflation through a combination of state subsidies, strict price controls and periodic wage increases. These policies became increasingly untenable, eventually leading to a severe economic crisis in early 1994 after Russia forced Uzbekistan out of the ruble zone. Faced with mounting economic problems accented by soaring inflation of the transitional currency known as the "som coupon", the Government began a genuine economic reform program including stricter fiscal policies, freeing of prices on most commodities, cooperation with international financial institutions, moderate steps toward privatization, overtures to foreign investors and institution of a permanent currency, the som. Since instituting these policies, the Government has been largely effective in holding the inflation rate to an average of 10-12% per month. According to recent estimates by the IMF, this rate could be reduced to 2% per month by the end of 1995.

While the Government still professes a gradual approach to economic reform and has not been averse to employing state controls, Uzbekistan has nevertheless attracted considerable support from the IMF and World Bank as well as other multilateral lending institutions. Praising the Government in January 1995 for "very significant steps taken towards stabilization," IMF Managing Director Michel Camdessus announced a $74 million Systemic Transformation Facility (STF) loan for Uzbekistan, promising an identical loan in six months if the country proceeds according to IMF plans. The World Bank has also committed to provide a $160 million rehabilitation loan. Moreover, more than $900 million were pledged in March 1995, by the Paris Club of official creditors.

Privatization will be a primary determining factor in the success of Uzbekistan's economic reform program. Some 20,000 enterprises were privatized or created in the first two years of independence, but these were almost exclusively small trade, construction, or transportation businesses. Examples of this process were successful small-scale privatization auctions carried out in Namangan and Bekabad in March and April 1994. Foreign companies were welcomed to bid on auctioned properties which were comprised mainly of hotels and restaurants. In conjunction with the January 1995 IMF loan agreement, President Karimov called for an accelerated privatization program with a greater emphasis on medium-and-large scale enterprises. Since then Karimov has promised to privatize 2000 enterprises in key industries such as mining, cotton, and machine tooling by the end of 1995. The Government has also offered to gradually free prices for basic foodstuffs including sugar, vegetable oils and flour. Moreover, wholesale energy prices are expected to reach world prices by the end of the year.

In the area of land privatization, a Presidential decree issued in July 1994 established procedures for the sale of state lands on which "trade and public service facilities" are located and called for the identification of specific plots to be placed on public auction. With respect to agriculture, the Government sanctioned the creation of approximately 6,900 leased farms representing 2% of Uzbekistan's arable land. Recent decrees commit the Government to privatizing fully 40% of all irrigated land through leased farms by the end of 1995.

Currency Issues:

Some of the most significant hindrances to private sector development in Uzbekistan are problems associated with the inconvertibility of the som. In July 1994, President Karimov issued a decree on the "introduction of the national currency" which provided a one month period for the withdrawal of the devalued "som coupon" from circulation in exchange for the permanent som. In an effort to avoid mistakes that had accompanied the issuance of the "som coupon" after Uzbekistan's expulsion from the ruble zone the Government instituted a combination of administrative controls on the value of bills and bank withdrawals, cutbacks in credit to state enterprises and a sharp increase in the discount rate. These measures were effective in curtailing inflation which fell from an average of 22% per month during the first half of 1994 to less than 5% per month by October.

An additional outcome of these policies, however, was a chronic currency shortage. This problem was further exacerbated in October 1994 when a decree by Uzbekistan's Cabinet of Ministers required enterprises, regardless of their form of ownership, to sell their products and services only in soms. Foreign firms and joint ventures were thereby obligated to obtain special patent licenses to convert and repatriate their earnings. The procedure for obtaining these licenses is often time consuming and fraught with bureaucratic obstacles. Interested companies are currently required to submit the following documents to the Central Bank's licensing department:

Notarized documents of accreditation, registration and operations.

Copy of the customs declarations on commodities imported by the applicant.

Statement from the National Bank of the Republic of Uzbekistan confirming the existence of a hard currency account.

Statement from a locally authorized bank confirming the existence of a local currency (som) account.

Even after obtaining the license foreign and joint ventures have often been required to provide justification for routine financial transactions relating to their own accounts. Moreover, companies earning hard currency are obligated to exchange 30% of their revenues for som at the official rate. This rate often contrasts with a significantly higher black market rate and occasionally results in foreign and joint ventures accumulating unwanted non-convertible currency accounts. As a consequences of these practices, many foreign and joint ventures rely on barter or countertrade arrangements to repatriate profits, despite Government efforts to limit these types of transactions.

In accordance with previous commitments, President Karimov issued a decree on July 1, 1995 lifting certain restrictions on the purchase of foreign currency from registered commercial banks. This move was presented as a first step in a plan to establish the full convertibility of the som over the course of the next year. While the full implications of this decree have not been realized, the $160 million World Bank Rehabilitation loan could provide the hard currency reserves needed to liberalize the exchange system without a serious devaluation of the som.

Foreign Trade Environment:

U.S. exports to Uzbekistan have grown at a steady rate since 1992 increasing at an average of 25% per year and reaching a total of $90 million in 1994. In 1993 the U.S. supplied nearly 20% of Uzbekistan's imports from the industrialized countries. U.S. imports from Uzbekistan, on the other hand, have remained low; at $7 million comprising only 1% of Uzbekistan's exports to the industrialized countries in 1993. Imports fell even more in 1994 to only $3 million. A $5.2 million surge in uranium imports from Uzbekistan in the first two months of 1995 has served to ease this trade imbalance somewhat though it is uncertain as to whether this volume can be sustained.

The bulk of U.S. exports to Uzbekistan have been agricultural commodities (primarily wheat), various types of industrial and agricultural machinery and to a lesser extent consumer goods. To date, the Government has exerted strict control over trade in what it considers "strategic" sectors including cotton, gold and certain other metals and hydrocarbons. Nevertheless, there is a keen interest in trade with U.S. companies in both the private and public sectors. An indication of this was the Government's decision in January 1994 to suspend all customs duties until July 1, 1995. Another edict issued in December 1994 reduced the Value Added Tax (VAT) on imports from 20% to 18%. While customs duties are expected to be implemented in 1995 (the Government has already exceeded its self-imposed deadline) these are unlikely to be prohibitive. The main intention of these duties will be to meet targets established under the economic reform program, as well as to prepare Uzbekistan for entrance into a CIS customs union should that be established. Importers of luxury items including alcoholic beverages, cigarettes, gasoline, machine-made carpets, jewelry, china, candies and furniture should also expect to pay excise taxes ranging widely from 5% to 94%.

Currently exports from Uzbekistan can be complicated by taxes ranging from 10% to 50%, especially for exports of "strategic" commodities. In these and many other cases, it is advisable to establish contact with the Ministry of Foreign Economic Relations as a first step in developing a trade relationship.

Uzbekistan entered into a Bilateral Trade Agreement with the U.S. in January 1994, providing for Most Favored Nation (MFN) status for the products of both countries. In August 1994, the U.S. granted Uzbekistan nonreciprocal tariff preferences under the General Systems of Preferences (GSP). This decision provides duty free access to U.S. markets for 4,400 semifinished products and agricultural goods. In April 1995, the U.S. Export Import Bank (Exim) signed an agreement with Uzbekneftegaz and the Japanese Export Import Bank to finance $125 million in exports from the U.S.-based Kellogg-Dresser for a natural gas recompression facility. This marks the first medium-term loan guarantee provided by the U.S. Export Import Bank in Uzbekistan. The bank expects to be active in more oil and gas related projects in the future.

Foreign Investment Climate:

No reliable data are available on total U.S. investment in Uzbekistan, though estimates for all direct foreign investment place the 1993 level at approximately $50 million and the 1994 level at $90 million. These figures are somewhat misleading in that there have been numerous sizable joint ventures established that promise to considerably boost the totals. Among these are an estimated total of $2 billion in foreign investment offered by the British American Tobacco plant (BAT), the South Korean Daewoo Corporation's auto assembly plant, and a Mercedes truck assembly plant. The U.S.-owned Newmont Mining gold processing venture has also committed over $220 million in foreign investment. Furthermore, smaller investments in the $1-5 million range are foreseen by a number of U.S. companies including plans by Coca Cola for the development of a bottling plant.

The following legal and regulatory developments in chronological order have been instrumental in the development of a generally positive foreign investment climate in Uzbekistan:

The "Enterprise Tax Law" of 1991 was amended in 1992-1994 to afford the following benefits to foreign and joint ventures: 1) All new companies, excluding trading companies, are only required to pay 25% of the standard income tax rate during their first year of operation and 50% during their second year; 2) joint ventures with more than 30 percent foreign ownership and specializing in consumer goods; agricultural machinery, agricultural production and food processing; medical equipment; light industries and recycling wastes (by-products); or building materials may obtain up to a five year income tax holiday from their time of registration.

In January 1994, President Karimov issued an edict "On Measures to Further Deepen Economic Reform, Facilitate the Protection of Private Ownership and Develop Entrepreneurship" which extends benefits already granted to joint ventures with greater than 50% foreign ownership and "specializing in the production of consumer goods." These include up to five year exemptions from requirements governing the mandatory conversion of hard currency earnings (see "Currency" section above).

In May 1994, Uzbekistan's parliament enacted a "Law on Foreign Investment" (FIL) which reiterates and, in some cases, extends guarantees on the protection of foreign investments provided by 1991 and 1992 FILs. These guarantees include (among other provisions): 1) protection against expropriation except in extraordinary circumstances and provision for compensation in that event, 2) the right to repatriate profits, 3) a ten year exemption (with some exceptions) from legislation subsequent to the formation of joint ventures having a negative effect on their operation, 4) licensing and tariff exemptions for exports of a joint venture's own production and for import of equipment to meet its production needs, 5) access to foreign arbitration.

The 1994 FIL is most innovative in its departure from previous conventions governing investment insurance. Superseding previous requirements that insurers work with the National Insurance Company (NIC), the 1994 FIL opens the market on a non- discriminatory basis to wholly-owned foreign subsidiaries which, along with joint ventures, have the right to deposit a portion of their funds in foreign banks as a means of ensuring coverage. Currently, foreign investors in Uzbekistan can choose from: several private firms that have entered into joint ventures with the NIC such as the American International Group (AIG) and Tokyo Marine and Fire Insurance, multilateral financing agencies such as the Multilateral Investment Guarantee Agency (MIGA) and the European Bank for Reconstruction and Development (EBRD) and U.S. Government programs including the Overseas Private Investment Corporation (OPIC) and the U.S. Small Business Administration (SBA).

A June 1994 decree on "Measures for Stimulating Enterprise Activity and Expanding Export Potential" states that all enterprises exporting 30 percent or more of total production will have their income taxes reduced by 50 percent. Hard currency export revenue reinvested to increase export productivity will be exempt from mandatory conversion and export tariffs will be lowered by 50 percent for all goods exported by producers for hard currency (see "Currency" and "Foreign Trade Environment" sections above).

In December 1994, the U.S. Government and the Government of Uzbekistan agreed upon a text for a Bilateral Investment Treaty (BIT) which codifies previous projections granted to foreign investors under Uzbek law within a formal legal and terminological structure agreed upon by both countries. The BIT provides added protection to investors in that it effectively translates Uzbekistan's foreign investment practices into terminology intelligible to U.S. corporations. The BIT was ratified by Uzbekistan's parliament in February 1995 and is currently awaiting ratification by the U.S. Congress.

In April 1995, President Karimov issued an edict "On Tax Reform in the Republic of Uzbekistan" which provides for taxation of enterprises based on net profit rather than income, limits the tax rate to not more than 38% and allows for standard deductions for wages, interest and other costs of doing business. The edict also upholds existing tax holidays, granting extensions to those enterprises which use their tax savings to develop production facilities. Moreover, in some cases, companies will have the ability to choose whether to apply the new profit tax or the preexisitng income taxes. Also, exporters of raw materials are exempted from the profit tax.

Foreign Travel Regulations:

Persistent problems for foreign investors have derived from the inconvertibility of the som (discussed above), limitations on freedom of movement, and cumbersome regulations governing the registration and licensing of foreign enterprises and joint ventures. Many of the problems relating to freedom of movement were resolved in June 1995 when Uzbekistan's Foreign Minister Kamilov signed a Memorandum of Understanding (MOU) with U.S. Secretary of State Christopher permitting U.S. businessmen and tourists to travel freely within the country. Prior to this, U.S. visitors were required to obtain separate visas for each city within Uzbekistan they intended to visit. Nevertheless, foreign visitors to Uzbekistan are still required to register in each city they visit, a process that can present difficulties (for example, when one is visiting a private residence). Moreover, it is unclear as to whether the accord will make it easier for foreign businessmen to obtain multiple entry visas, which are currently quite expensive and involve a cumbersome approval process.

Licensing and Registration of Foreign Ventures: Problems associated with licensing and registration of joint ventures and foreign enterprises tend to be complex and are unlikely to be resolved entirely in the near future. In addition to considerable bureaucratic obstacles which slow down the process, the underlying regulations governing registration are extremely unclear, making it difficult to determine exactly which approvals are needed and how these approvals should be obtained. An inquiry by the U.S. Commercial Service in Tashkent in February 1995 resulted in a cursory overview of the process for joint ventures, though changes instituted since that date may invalidate much of this information. As yet, regulations governing wholly-owned foreign subsidiaries (as opposed to joint ventures) have not been explicitly outlined. The following information is therefore provided for the sake of perspective and should not be taken as the final word.

As of February 1995 the Ministry of Finance was the primary authority within the Government of Uzbekistan governing the registration and licensing joint ventures. However, a Presidential edict issued in January 1995 called for the transfer of this authority to the Ministry of Justice as of March 1, 1995. It is presently unclear as to whether this transfer has taken place. In either case, U.S. companies seeking to establish a joint venture in Uzbekistan are required to submit the following documents to the appropriate governing authority:

For major joint venture projects, the decree of the Cabinet of Ministers on the formation of the joint venture. For small and medium-sized projects, the document specified in Paragraph 3, Part D is required.

Copy of the registration application obtained from the Ministry of Finance (or Ministry of Justice).

Proof of project approval from the appraisal commission of the principal Hokimyat (Mayor's office) where the joint venture was formed. This calls for a separate approval process that may vary from one Hokimyat to another.

Copy of the resolution from the governing ministry which oversees the industry under which the Uzbekistani venture partner falls.

Two notarized copies of the Charter (By-laws) and articles of incorporation.

If the Uzbekistani venture partner is state-owned, the resolution of the Ministry of State Property and Privatization (GKI). If the Uzbekistani venture partner has already been partially of fully privatized, a copy of the document certifying the form of ownership exercised by the local venture partner.

Receipt for payment of the registration fee to the Ministry of Finance (or Ministry of Justice) in soms.

Copy of the document confirming the transfer of 30% of the foreign partner's capital investment (in hard currency) into the charter fund of the joint venture.

Joint ventures seeking to engage in "foreign economic activity" may also need to register with the Ministry of Foreign Economic Relations. In the past, the following information has been required:

An application addressed to the Minister of Foreign Economic Relations requesting registration.

A detailed profile of the foreign partner (including: country of origin, legal address, nature of business as a joint venture partner and in its foreign operations).

Information on the joint venture's foreign bank accounts.

Information on the foreign principals of the joint venture (including: complete names, dates and places of birth, citizenship, and permanent addresses).

A registration card (four copies) affixed with an official seal and signed by the general manager of the joint venture.

Certificate of registration issued by the Mayor's office.

Information on the products and services to be traded.

Certificate of registration issued by the Ministry of Finance (or Ministry of Justice).

It is important for joint ventures in Uzbekistan to note that they are permitted to operate only in accordance with the clauses defining the range of their economic activities in their corporate charter or by-laws. These tend to be quite explicit. A potential consequence of this is that contractual obligations calling upon joint ventures to exceed the activities allowed under their charters will be considered null and void.

In general, the obscurity of the regulations governing the licensing and registration of foreign ventures, obliges interested U.S. companies to enter into dialogue with appropriate ministries (e.g. Ministry of Finance, Ministry of Justice, Ministry of Foreign Economic Relations) at an early stage of project development. The most successful foreign ventures have worked in close collaboration with these ministries. BISNIS and the U.S. Commercial Service in Tashkent may also contribute useful insights as to appropriate contacts within the Government of Uzbekistan.

The texts of existing laws on foreign investment, taxes, privatization and ownership are available in translation from the National Technical Information Service. These laws may be ordered by calling (703) 487-4360.