European Bank for Reconstruction and Development in Kazakhstan
Kazakhstan interviews Michael Davey, Director of Kazakhstan and Kyrgyzstan Team of the European Bank for Reconstruction an Development
What is the role and objective of EBRD in the process of reforming the Kazakhstan economy?
EBRD’s role is to promote the transition of Kazakhstan’s economy through the provision of investment finance and advice in a manner that directly supports the operation of a healthy market economy. The Bank’s portfolio in Kazakhstan includes debt and equity and loans to the private sector without sovereign guarantee as well loans to the public sector. Our focus is primarily on provision of investment finance to enterprises with private sector ownership with around 20 % of our operations being of a public sector nature, mainly for the financing of key infrastructure projects. Within the private sector, we lend and invest with very large enterprises such as the Ispat Karmet steel works in Temirtau as well as to very small enterprises. A high priority is provided by EBRD to programmes such as the Kazakhstan Small Business Programme, which has become a real success and which has now provided finance to more than 7,000 small businesses throughout the country. Financing of community businesses is an excellent way to promote transition. The EBRD does not have concessional loan funds and its lending and investment is undertaken on strict commercial terms. It is important that we make a profit from our operations in order that we can continue to access funding from the world capital markets at favourable terms.
Technical assistance provided by EBRD is normally financed on a grant basis from special resources provided to the Bank by shareholder countries. Usually this technical assistance is of an advisory nature and is provided in areas that directly support our investment activity. Good current examples include the advisory technical assistance that EBRD is providing to enable privatisation of Regional Power Distribution Companies to proceed and assistance being provided to the Ministry of Transport and Communication for strengthening the regulatory framework for telecom activities. This latter work is expected to create a significantly better environment for ‘New Economy’ investment in Kazakhstan.
What is EBRD’s primary objective? To contribute through finance and expertise to Kazakhstan society’s ongoing development as a healthy society, providing the necessary income-earning opportunities and clean environment that we all aspire to. This country has tremendous resources, opportunities, talents and values. The EBRD wants to be an integral part of ensuring that coming generations can take best advantage of these attributes.
Could you please tell our readers more about the EBRD activities as a member of the Foreign Investors Council under the Kazakhstan President? What are the main problems FIC faces in its relationships with Kazakhstan authorities and what are the prospects for improvement of the investment climate in the country? Why the EBRD raised the issue to study the damage of cumulative costs under the projects implementation?
The EBRD has been an active member of the FIC from the very start when the council was established back in 1998. In fact, the idea to set up the FIC as an instrument for dialogue between the Kazakhstani authorities and the foreign investors was born during a discussion between President Nazarbaev and the then EBRD President DeLarossiere in late 1997, based on the Bank’s experience with a similar forum in Russia. Ever since, the Bank has been playing a leading role in securing a constructive dialogue between the parties involved. The issues that the FIC members face vary in their form and substance. For the sake of clarity and ease of reference these could be broadly classified in the following clusters: (i) issues related to the legal and judicial environment. Typically, these include analysis of the existing and drafted legislation and sub-legislative regulations. The new Foreign Investment Law, court structure, arbitration of disputes, the Law on Judicial System and Judges are some of the issues discussed here; (ii) taxation is another field of major focus for the FIC. The new Tax Code was obviously a core issue. I am sure you will agree that the taxation regime in a given country could play a role of an incentive or disincentive to investment and economic growth. A clearly defined and consistent government policy in this respect is essential; (iii) the operational environment is another rather broad field of activity, which naturally also covers aspects of all other fields. A major issue constantly under discussion here is the so-called sanctity of contracts. In other words, any investor, national or international, needs the comfort of well-tailored and strictly honoured contractual obligations. All parties to a contract should be equally treated and the existing and drafted legislation should clearly provide for it. The alternative is a great degree of uncertainty, limited commitments and reluctance for further investments; (iv) image enhancement is another important direction of the FIC’s activities. Administrative efficiency, reduction in bureaucracy, simplified visa procedures for investors and the fight against corruption are a prime focus in this area. All these factors directly affect business and investment decisions and thus have a potentially damaging effect on the economy, if not addressed properly and on a timely basis. The proposed Cumulative Delay Effect study, backed by the EBRD and other members of the FIC, is designed to provide evidence on what the various bureaucratic hurdles actually do to investors and to the Kazakhstani economy.
What are the advantages and disadvantages of Kazakhstan’s investment legislation as compared with the other CIS states?
Kazakhstan has had relatively advanced investment legislation since 1994. This legislation protects the basic rights of foreign investors. The most important such rights concern the protection of legal title to property, compensation for damages due to legal violations by state bodies, and provisions for settling disputes over contract violations. By and large, Kazakhstan has provided adequate protection of these rights and may be regarded as one of the front-runners in the CIS.
However, one of the biggest obstacles foreign investors still face in Kazakhstan is uncertainty over the legal environment. Some of this is unavoidable, given that Kazakhstan as a transition economy will continue to experience rapid change to its economic structure and its institutional framework. When circumstances change, there is always the temptation for policy makers to renegotiate contracts and adapt legislation. But investors need to know before committing funds that their business will remain viable in the face of such changes. Kazakhstan does not provide sufficient assurance to investors in this respect, and the abolition of the stabilisation clause in the foreign investment law is therefore problematic.
It is also important to point out, that conditions faced by foreign investors can differ very substantially in Kazakhstan depending on which sector the investment is made in, and on the size and political weight of the investor. Kazakhstan needs to do more to attract investors into the non-oil sector of the economy, where investors rarely have the ability to negotiate tailor-made contracts. In this respect, improving the judicial system is key to make protection offered under the existing legislation effective in practice.
Could you define the major problems encountered by foreign investors when implementing projects in Kazakhstan? In your opinion, what are the ways to solve these problems? Could you please tell us about the position of the EBRD regarding the reforming process in the Power sector of Kazakhstan?
As mentioned above, Kazakhstan still discourages investment because of uncertainty over the sanctity of contracts, over the legislative environment and over the enforcement of existing legislation through the courts. Once a project is up and running, investors also face problems relating to tax administration and the administrative burden of multiple inspections, the speed and efficiency of customs procedures, the regulation of foreign labour and a number of sector specific issues. EBRD has just commissioned a study for the Foreign Investors’ Council which will look in detail at these obstacles to try and estimate how much Kazakhstan as a country is loosing in economic value as a result of these various obstacles. These findings will further sharpen the focus of the suggestions for improvement, which are already being elaborated in the working groups of the Foreign Investors’ Council.
To give you one concrete example of an improvement, which was decided on last year - as a result of our joint efforts Kazakhstan, subject to endorsement by the Ministry of Justice, is about to start producing an Official Gazette. This will greatly enhance access to key legislative information for foreign and domestic investors. And what is more, the Gazette is to be printed by a private entrepreneur, and in this way we are even supporting the growth of the new private sector.
Concerning the power sector, as you know EBRD has a long-standing commitment to reforming the sector as evidenced in our investments in Karaganda Power, Altai Power and KEGOC. We believe strongly in the benefits of commercialisation and unbundling in the power sector, which has also been the basis for the government’s reform efforts. However, these reforms are currently facing a number of challenges. The most important one is to make sure that tariffs are adjusted to reflect economic costs, otherwise key investments will not be undertaken and efficiency improvement cannot be realised. This will cause social difficulties, which the government may wish to target with special money transfers. Once this commitment has been reinforced, privatisation of the distribution companies can move forward and a domestic market for power can gradually be created. However, one cannot overemphasise the importance of adequate regulation if the reform of the power sector is to succeed. This is a challenge even in advanced market economies, as the case of California demonstrates. EBRD is supporting the regulator with technical assistance. We hope that this will be complemented with political commitment at all levels to the principles of commercialisation, cost recovery and efficiency that form the basis of reform in the sector.
In the draft investment law, the Kazakhstan Government is proposing the lawmakers to abolish the stabilisation provisions provided by the Investment Act currently in force (article 6). In your opinion, what would be the consequences of such decision, if made, for Kazakhstan and for foreign investors?
The so called «stabilisation provisions» are typically characteristics of developing and transition economies. Such clauses are often needed and applied in the emerging markets where investors need extra comfort. It is a largely political decision that the relevant authorities must take. If decision-makers believe that attracting direct investment is crucial to the socio-economic development of a country going through a complex transition process, a stabilisation clause is simply needed. A decision to the contrary will inevitably send the opposite signal to investors, thus diverting much needed investment inflows.
It is a well-known fact that the Kazakhstan Government is planning to offer investors to replace the provisions of article 6 with insurance of political and regulatory risks. What positive and negative effects will it produce on the investment climate in Kazakhstan?
Most developed market economies do not need stabilisation clauses to attract foreign investment. In the more advanced central European countries, the grandfathering clauses in the legislation are now being phased out. However, as explained earlier Kazakhstan still faces great uncertainty over future economic and institutional changes. In principle it would of course be possible to insure investors against the risk of adverse policy changes. There are two issues to consider here, however.
If insurance against policy risk is provided by the government and it is full and comprehensive, then its effect is the same as a stabilisation clause - with the only difference that the government can charge an insurance fee. But then it is not clear, why the legislation needs to change, as such a fee could be incorporated into the value of the original contract.
If insurance were provided by other parties, they would need to have some ability to pool risks and exercise leverage over the government to minimise damaging policy changes. EBRD as well as other IFIs can provide such insurance against political risk through a variety of instruments. However, this cannot effectively substitute for a stabilisation clause, as it would be incomplete and costly. The best solution for foreign investors would be to complement protection provided under existing legislation with political risk guarantees, such as offered by MIGA or under EBRD financing.
Moreover, Article 24 of the proposed new draft law makes insurance voluntary for foreign investors. This essentially leaves it up to the individual companies to judge whether they would be vulnerable or not to unanticipated policy changes. However, the most vulnerable may be precisely the kind of investors that Kazakhstan wants to attract - companies investing in manufacturing without the political clout of a big oil firm; companies operating under the principles of arms’ length with the government and full transparency, which are not able to benefit from «connections». The shift from a stabilisation clause to insurance penalises these companies over others, with potentially undesirable consequences for Kazakhstan. In summary, therefore, we would argue to keep the stabilisation clause in for the time being and to review whether it is still needed once Kazakhstan’s economy has settled a bit more.
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