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  KAZAKHSTAN International Business Magazine №5/6, 2001
 Cumulative Costs of Delay in Investment Projects in Kazakhstan
Cumulative Costs of Delay in Investment Projects in Kazakhstan
Executive Summary
At the request of the Government of Kazakhstan, the Ministry of Foreign Affairs, the Foreign Investment Advisory Service (FIAS), a joint facility of the International Finance Corporation (IFC) and the World Bank, conducted a study of the Cumulative Costs of Delay in Investment Projects in Kazakhstan.
The FIAS mission visited Kazakhstan from April 1 through April 15, 2001, and worked closely with the Foreign Investors Council which provided invaluable assistance before, during and after the mission. FIAS would like to thank the staff and members of the Foreign Investors Council of Kazakhstan (FIC) for their support and collaboration. FIAS would also like to thank the private domestic and foreign enterprises that participated in the study and without whose support this analysis would not be possible.
Administrative delays are clearly an issue in Kazakhstan?
Kazakhstan’s FDI inflows over the past five years have been quite strong, and have increased from 5.7% of GDP in 1995 to 10% of GDP in 1999, with the absolute investments growing from US$960m to US$1.6bln over the five year period. However, such inflows have been heavily concentrated in the extractive sectors with relatively little FDI in the manufacturing or services sectors. Those investors that have set up businesses in Kazakhstan, including major multinational and global companies, have had many problems, causing project delays and increased transactions costs. There is a perception that these delays result from a mix of bureaucratic red tape, political interference and corrupt practices. In addition, elevated transactions costs which often originate from excessive regulation and/or inefficient enforcement of regulations, excessive costs of infrastructure services, poor contract enforcement and unfair and lengthy conflict resolutions, substantially increase the costs of doing business. Overall, the resulting delays and transactions costs do not only impose substantial financial costs on the companies involved, but also present a major burden for the economy of Kazakhstan by slowing down the country’s industrialization process, denying employment and entrepreneurial opportunities to the local population, and resulting in a loss of tax revenue because of reduced economic activity.
…and the cumulative impacts of these delays can be significant…
Individually, transactions costs and administrative delays might not seem too arduous. However, if there are many of them, they can add up, and cumulatively, increase costs, delays and uncertainty to a significant degree, for investors. A delay of a few weeks at each of several government agencies may seem of little consequence to the responsible official in each agency, and they may even profit a little from the delay, but cumulatively it can cost an investor thousands of dollars in wasted time and lost revenues. The analysis in this report suggests that the overall impacts of administrative delays on the economy can be very significant. As part of this study, four projects were analyzed in depth in the oil/gas and telecom sectors. In oil and gas, the largest sector, our analysis indicates that the economic impact of cumulative delays on GDP could be fairly substantial and could range from 3% to 6% over the next five years if the regulatory processes are not streamlined. In the case of the relatively smaller telecom sector, the results indicate that the costs of cumulative operational delays are about 0.15% of GDP. These findings indicate that delays are not confined to a single sector and are clearly systemic. Delay impacts of these magnitudes set the wrong tone with investors, especially with small-and-medium-sized investors (SMEs) with limited resources and export-oriented firms that could locate to competitor nations with more conducive business environments.
… but should Kazakhstan worry?
Since independence, the Republic of Kazakhstan has been going through a comprehensive economic and political reform process. The Government has completed an extensive privatization program, including many of the major state-owned enterprises. Numerous new laws and regulations have been passed to develop a more open and market-oriented business environment. More recently, following the crisis in 1998, Kazakhstan went through a devaluation in 1999, an increase in commodity prices, an export recovery, all of which have contributed to increased growth and renewed investor interest in Kazakhstan since the end of 1999.
Relative to most other CIS countries, Kazakhstan also compares favorably in terms of FDI inflows as a percentage of GDP. Kazakhstan has world class resources including oil, natural gas, coal, uranium, gold, aluminum, lead, copper, zinc, iron ore, and many international companies recognize that there is a strong risk in not being part of the potential development of these assets. Of all the potential investments, oil has emerged as the key sector to insure long term economic growth.
…yes, given the difficult business environment.
The dependence on the oil sector could increase the economy’s vulnerability to external and domestic factors, such as the cyclical nature of oil prices, if the government fails to broaden the tax base through fiscal reform. There are signs of growing restrictions on aspects of foreign investors’ activities, and the treatment of foreign investors outside of key export sectors such as oil remains poor.
For investments other than in oil, Kazakhstan is not considered as an attractive location by multinational investors. Partially this is the result of the location of the country–being landlocked and remote from the most important global markets. But to a large extent the reluctance of foreign investors goes beyond these issues. According to a report by the International Tax and Investment Center,1 one of the leading competitive disadvantages of the business environment in Kazakhstan is bureaucratic ‘red tape’. In a recent survey by FIAS, 73% of enterprises were dissatisfied with the current state of the regulatory environment.2 On average, investors in Kazakhstan reported that about 23% of management time is spent dealing with government regulations and administrative requirements, compared to only four percent in several Latin American countries.3
1Special report on the Investment Climate in Kazakhstan, 1999.
2 Administrative and Regulatory Costs Survey, FIAS, 2001.
3 World Business Environment Survey, World Bank, 2000.
Clearly, Kazakhstan presents a difficult business environment, so different from investor expectations and international practice that investors are hesitant to commit their capital, with the exception of those in the extractive sectors. The Government clearly needs to take decisive steps to transform the country into a more attractive investment location. At the practical level this will imply significant improvement in the existing legal, regulatory and administrative framework, combined with a comprehensive effort to enhance institutional capacity for implementation of reforms and delivery of services.
Common roots of investor troubles with Kazakhstan’s administration
Kazakhstan is not a preferred investment location because investors consider the investment environment as not sufficiently attractive when compared to what other countries have to offer. While past political and macroeconomic instability, slow pace in key policy reforms, and complicated, high-cost tax system have created a generally unfavorable image of Kazakhstan as an investment location, the country is also notorious for its complex and convoluted bureaucracy, making it all but easy to establish and efficiently operate a business. Many of the problems investors face are common throughout the administrative system as a whole. Based on field investigations, four major themes, or underlying root issues, emerge regarding the administrative obstacles to investment in Kazakhstan:
I. Inconsistent Implementation and Interpretation of Laws and Regulations
Kazakhstan has made excellent progress in developing a proper platform for a functioning legal system, but the implementation and enforcement of these laws is far from perfect. In the course of the FIAS mission, the problem of inconsistent implementation and interpretation of laws and regulations was a recurring theme. Such inconsistency, in turn, can give rise both to discrimination between different types of investors (foreign/domestic, large/small) and to corruption. Even where corruption is not an issue, and even if two differing interpretations are both «reasonable», investors often can not tolerate an outcome that treats competing companies differently. A firm that is treated more harshly by the tax authorities than another firm faces obstacles and costs that the other firm avoids. A firm whose imports are held up at the border is seriously disadvantaged relative to a rival whose imports clear customs expeditiously. For this reason, inconsistency can not be dismissed as a «minor» problem. This problem of inconsistency has various sources. Laws change frequently, and implementing rules and regulations are often enacted only with significant delays. Civil servants and the private sector alike tend to be unsure and badly informed about the latest changes and the interpretation of laws in practice. Civil servants also will treat investors differently, depending on their willingness to make «unofficial or facilitation payments». The most unfortunate part is that these practices also seem to apply to the judiciary, resulting in inconsistencies even in the court system. The result of all this is that the private sector currently has no confidence or trust in Kazakhstan’s legal system, and has resigned itself to handling this continuous stream of inconsistencies and uncertainties through alternative means outside the formal process of law and administration. Many of the larger foreign investors try to obtain a more favorable decision through direct contacts with ministers or senior government officials whenever they encounter difficulties.
II. Unofficial payments
As is common in most transition economies, Kazakhstan suffers from an excessive use of «grey economy» practices outside the formal legal and administrative procedures that usually guide the relationship between civil servants and the private sector. As in many countries, corruption poses a particular problem.
Making «unofficial payments» has turned into a generally accepted way of doing business in Kazakhstan. According to the World Bank Business Environment Survey (WBES), 63% of investors ranked corruption as a serious obstacle to investment in Kazakhstan and on average, 4% of the firms’ annual revenues are spent on unofficial payments. According to investors interviewed by FIAS, for most bureaucratic procedures, civil servants demand side payments with the threat of delaying or complicating it in case the investor refuses to pay. While these practices and conventions might work reasonably well for Kazakhs, they pose serious problems for investors, particularly those from OECD countries. Any type of «unofficial payment», independent of its size, represents bribes and corruption. This will always make such investors uneasy, as they are used to base their investment decisions on a clear and enforceable legal framework and transparent administrative procedures. Most serious investors will be unwilling to invest with the danger of becoming engulfed in serious legal difficulties because of corruption or illegitimate practices.
III. Insufficient Institutional Capacity
Inconsistencies in implementation of regulations also partially result from the fact that most government agencies are struggling with insufficient human and financial resources to implement new policies. The coordination among the different government agencies is hampered by the lack of reliable and standardized means of communication. Computer networks and central filing systems tend to be lacking, resulting in mis-communication and significant overlap in the work done by different agencies. Few resources seem available to increase the flow of information about the basic government policies and procedures as well as the latest reforms and changes. Efforts to train civil servants in the consistent interpretation of changes in laws and regulations appear few and sparse. Similarly, simple brochures and other public relation material to inform the public about policies and procedural steps frequently do not exist, making it difficult for investors to gain a basic understanding of the relevant administrative procedures.
IV. Suspicious Attitude Towards the Private Sector
But the administrative problems seem to go beyond the lack of resources or reform coordination. Possibly as remnants of the past, many administrative procedures are designed based on control mechanisms, while user-friendly elements tend to be missing. Investors generally seem to experience a strong degree of suspicion in the various administrations. Inspections and audits are frequent, generally going beyond the concept of market surveillance to ensure that private business operations are in line with the country’s laws and regulations. Inspectors appear to be driven by a mix of generating revenue for the state budget as well as benefiting personally through «unofficial payments» and bribes. Based on this motivation, civil servants typically appear to view businesses not as clients, but rather as potential or likely violators of the country’s laws. They always seem keen to identify infractions and violations, even if minor in nature and without serious suspicion of major wrongdoings or fraud. Correspondingly, investors always are on the defensive, feeling harassed by government agencies without any legitimate means at their disposal to prevent the recurring abuse of power by government officials.
Causes for Administrative Delays in Project Implementation
Discussions with investors revealed that excessive time and money was being spent to comply with administrative and regulatory rules and procedures. No matter how small these administrative issues seemed, they nonetheless raise the cost of doing business and pose a serious bottleneck for stronger investment activity in Kazakhstan. Some of the main causes for delays include:
Investor Entry. Opening a new business in Kazakhstan, as in many countries, can be a complex and arduous task. The duration of time required for initially registering a new business in Kazakhstan could be up to 41 days, under the large assumption that every step of the process is successfully approved. If a step is rejected or additional information is required, the processing clock stops until the problem is resolved. On a comparative basis this is not as expedient as procedures designed to attract new investments in many other countries, such as Malaysia and Hong Kong where the process takes about 5 days. There appears to be an excessive regulatory burden, requiring a dedicated staff to negotiate with different levels of inspectors. The perception of excessive regulation could encourage new firms to initially operate in the informal sector, and payment of fees to government officials to remain in the shadow economy.
Taxes and Tax Administration. The official tax and fiscal policy in Kazakhstan initially encourages foreign investments; however, the reality of daily operations provides continued examples of delays and uncertainties. The commitment and financial design for a long-term investment requires a consistent and understandable tax and revenue structure. In the case of Kazakhstan, the total tax burden imposed on private firms was considered higher than in other countries. New tax rules and regulations have been imposed retroactively, which required adjudication, further increasing costs, delays and uncertainties. Revenue collection is an area susceptible to corruption and associated with delays. Tax inspectors visit frequently and seem to wield enormous discretionary power. Assessments of tax reporting violations appear arbitrary, focused on finding infractions to generate penalty assessments rather than on finding major violations and serious cases of tax fraud.
Customs. In the area of customs, some progress has been made in streamlining customs imports procedures and improving service provision. Despite these reform efforts, investors report a slow realization of the benefits of reform and many continue to face very serious problems associated with importing and exporting, including transportation stoppages, implicit or explicit requirements for bribes, excessive paperwork, and continued lengthy delays.
Work Permits for Expatriate Labor. Acquiring international experts can be a costly and time consuming practice for companies. There is an exceptionally long process for bringing expatriate workers into Kazakhstan, which can take several months for each applicant, requiring approval at both the Oblast and national level in Astana. Each approval step is time consuming, requiring multiple levels of documentation and health assessments for each employee. Adding to the investors’ risk is the possibility that a potential employee can be rejected without an explanation.
Legal System. There have been frequent changes in laws and regulations, increased conflicts and inconsistencies in the process. Of particular concern are the rights of investors to property and the process for settlement of disputes. Although the legal framework is evolving, all new investments must be made under a consistent set of laws and the frequent conflict in interpretation has added significantly to investment risks and delays in every sector of operations.
Government Bureaucracy. The bureaucracy was noted by all investors interviewed as a major concern, initiator, and cause of continued delays. There are overlapping jurisdictions between the ministries with conflicting agendas. The Government Ministries and civil servants now based in Astana, appear to maintain the old central command and control approach where the Government has a defined interest in the decisions and operations for each investment. The relatively low remuneration levels for civil servants encourages them to leave for private companies once they have mastered the details of each agency. The frequent change in staff requires periodic re-education and training of each civil servant in the intricate details, as well as regulations, of the diverse operations. Until the process has been corrected or individuals retained on a long-term basis, frequent and unexpected delays will occur. This can result in arbitrary conclusions and unjustified claims that must be adjudicated at a higher Government level. This delay can be caused by intentional control, or a desire to receive bribes, or from simple ignorance.
Judicial System. When disputes develop between the interpretation of the conflicting laws, the judicial system, instead of helping, appears to add to the problem of delays. Some investors indicated a low level of confidence in the ability of the courts to adjudicate disputes in a fair and equitable manner. According to foreign investors and legal experts, the courts frequently do not accept foreign court decisions or awards. Foreign investors appear to have little recourse to court decisions except to close or reduce operations, and the uncertain period of time in obtaining court decisions can add to the delay.
Priorities and recommendations for reform
It is clear that the transformation of the business environment of Kazakhstan towards a market-oriented economy is a challenging task. Many of the reform needs are likely to be difficult and lengthy, especially because many areas relate to cultural attitudes which will take time to change. The Government might therefore be well-advised to focus its attention on a couple of core issues. Most important will be the weeding out of practices related to «unofficial payments» as a means to get around the country’s legal and administrative system. To tackle this issue strategically, it might be desirable to try to develop centers of excellence within the administration. For example, in areas such as customs and taxation, new procedures and measures can be tested regarding their effectiveness in designing transparent and customer-friendly processes.
Table presents a brief summary of this study’s key recommendations. This report lists many recommendations and areas in need of reform, not all of which are equal in importance, and it would be nearly impossible to take them all on at once. Further, some recommendations, such as tax reform, will take more time to design and implement, and warrant interim measures in parallel to improve conditions. Others, such as streamlining business registration requirements, can be implemented relatively quickly and easily. In the immediate term the focus should be on the following areas:
• Develop a more centralized registration process with an entity overseeing the entire process for the general registration process
• Create transparent registration requirements and procedures and make them easily accessible to the public.
Tax Administration
• Eliminate the «audit pressure» system by focusing on sampling of reporting and pursuing only major suspected mis-reporting.
• Strengthen the legislation and enforcement for audits and inspections to limit and contain the discretionary power of inspectors.
Work Permits
• Provide transparency on the determination of the quota and the distribution of permits by oblasts.
• Balance the allocation of permits among foreign companies to ensure consistency in the use of the quota.
• Reduce the time involved in obtaining a permit.
Legal Environment and Settlement of Disputes
• Maintain Contract Stability. Indications that the Government plans to change the terms or conditions of the established agreements creates a risk that continued investments in existing projects will be reduced and new projects will be curtailed. The GOK has to provide a stable and consistent policy that will continue to be attractive to the investors.
• Enact the draft Law on Investments to eliminate existing uncertainties regarding the status and rights of foreign investors.
Action is Needed for Implementation
This report intends to provide a starting point by identifying the need for a range of administrative and policy-level reforms that need further review and additional technical assistance. The challenge is to develop an agenda for implementing effective change, building on the many ongoing legislative and administrative reforms, and creating the momentum for a sustainable process of improving the investment environment. Government commitment is required at all levels: national, Oblast and local. The framework for the change agenda must include:
(a) the participation and inputs of the public and private sector
(b) a suitable institutional structure to facilitate change,
(c) a sound system for monitoring and evaluating change, and
(d) adequate resources for capacity building and implementation.

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