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 KAZAKHSTAN International Business Magazine №1, 2003
 Investing in Kazakhstan – Opportunities and Threads for German Investors
Investing in Kazakhstan – Opportunities and Threads for German Investors
Michael F. Krause, Consultant for a Kazakh Government organization under the German Government sponsored CIM program1
1. The article expresses solely his personal opinion. The author would like to thank Dr. Christian A. Schmidt, World Bank for valuable remarks.
Current state of German Investments
Political relationship between Kazakhstan and Germany has always been good. Germany does not have, other than e.g. the United States geostrategic interests in Central Asia. Germany was one of the first countries to recognize Kazakhstan as an independent state. Important treaties avoiding double taxation are in force. More than one million ethnic Germans lived in Kazakhstan, hence the German Government has always been prone of enhancing living conditions in Kazakhstan to prevent those ethnic Germans from emigrating to Germany.
As of March 2002 German companies have invested $580.4m into the Kazakh economy of which $248.8m have been direct investments, $6.0m portfolio investments and $325m financial investments.
This sum of direct investments does not make Germany a significant investor in Kazakhstan if compared to countries like the USA ($5.6bn), Great Britain ($2.1bn) or even countries like Turkey ($376.2m) or Canada ($430.6m).
Even worse, many of these investments had to be written off. Quoting unofficial sources, losses amount to approximately $200m until today. Preussag Energie, a large investor will shut down its operations in Kazakhstan by the end of this year. Furthermore the trend of German investments is clearly negative as the majority of funds have already been invested in 1993 to 1997, and investments since then steadily declined, e.g. direct investments in 2001 have only amounted to $23.6m. Encouraging new investments like Knauf’s $18m into AO Gyps have only been made possible through the involvement of DEG Beteiligung, a German government organization, that took part of the risk.
Trade relations between Kazakhstan and Germany are in a much better state. Total trade turnover during the first nine months of 2002 amounted to $572m of which $152.8m have been Kazakh exports to Germany and $419.2m Kazakh imports from Germany. This makes Germany (after Russia) the second largest importer to Kazakhstan while is the Germany the fifth largest importer of goods from Kazakhstan.
Hermes’ assigned Kazakhstan a country rating of 6, Coface a corresponding rating of C .
In the case of Kazakhstan the common practice “investments follow trade” seems not to be valid. Kazakhstan does not show up on the roadmap of German investors, especially those Trans National Companies (TNCs) like chemical giants Bayer and BASF or the automotive producers Volkswagen, Daimler or BMW that invest large sums of money in all parts of the world. Bayer even downscaled their trade office in Kazakhstan last year, due to what they claim irregularities in tenders they participated in. It should be worth mentioning that Bayer is currently investing $6bn in China, mostly in the petrochemical industry. It should be also worth mentioning that Germany is the largest investor in Central and Eastern Europe (21% of all Foreign Direct Investments) and Russia ($6bn).
This article makes an attempt to explain German investors’ reluctance to invest into the Kazakh economy and to propose measures to reserve the trend. 
Framework for Foreign Direct Investments into Kazakhstan
It can not be denied that Kazakhstan has already received significant amounts of Foreign Direct Investments totaling $23.4bn by the end of October 2002. GDP growth is strong (9.5% in 2002), inflation moderate (CPI 2002: 6.6%). The banking sector is one of the most developed in the former CIS and the country’s credit rating (Moody’s Government Bonds Foreign Currency Long Term Rating: Baa3 ) has for the first time reached investment grade.
Should Kazakhstan therefore be concerned about its investment climate? Or is Kazakh’s Ambassador to Germany Vyacheslav Gizzatov right when he quoted German philosopher Hegel in connection with German investments in Kazakhstan. When Hegel was told that his theory contradicted the facts, he answered, too bad for the facts.
The majority of Foreign Direct Investments flow into the natural resources sector especially into the oil and gas sector. The fact that an oil rich country attracts investments in this sector is not unusual. Even Nigeria, one of the worst investment locations in the world attracted more than $22bn in investments. Large international oil companies know very well how to operate in an uncertain environment and what risk premium they have to charge.
Focusing on the oil and gas sector clearly made the Kazakh economy vulnerable to the cyclical nature of oil prices.
At the same time Foreign Direct Investments are concentrated in a few large enterprises. Some regions received hardly any investments at all, leaving them behind the others. This caused the Kazakh Government to acknowledge the necessity of diversifying the economy. Foreign Direct Investments can help in this respect. There is growing evidence that enterprise productivity, R&D expenditure and company performance are higher in foreign owned firms.2
2. Bevan, Estrin, The Determinants of Foreign Direct Investments in Transition Economies, Centre for New and Emerging Markets, London Business School
According to a survey by FIAS, the World Bank’s Foreign Investment Advisory Service on “Costs of Unnecessary Bureaucratic Procedures and Delays” Kazakhstan is “not a preferred investment location because investors consider the investment environment as not sufficiently attractive when compared to other countries.”3
3. The report can be downloaded from the website
Many of the factors constraining foreign investments do of course not only affect German investors but all investors. Nevertheless it is necessary to mention them. Key factors determining Foreign Direct Investments are the market size of the recipient country, production input cost, and the riskiness of investments.
As Martha Brill Olcott, one of the most profound experts on Kazakhstan has pointed out, business in Kazakhstan has always been dominated by those who are “in” of political favor. The conditions of a market economy has allowed these groups to translate political influence into vast capital holdings.4
4. Working Paper: Revisiting the Twelve Myths of Central Asia, Carnegie Endowment for International Peace
When it came to billion dollar investments into the oil and gas sector in the early 90s it appears that American, British and Italian investors could better cope with the challenge of doing business with these business circles.
Except from billion dollar investments in the oil and gas sector, investment projects in Kazakhstan do not fail for of a lack of money. Even if Kazakh businessmen are not ready to invest, international financial institutions like the European Bank for Reconstruction and Development, Asian Development Bank and Islamic Development Bank or the Kazakhstan Development Bank have more money committed to Kazakhstan than can be absorbed and usefully invested.
What is lacking is managerial input, technical know how, knowledge of export markets and other things that could easily be provided by German Mittelstand (mostly owner managed medium sized companies with up to 500 employees) companies that dominate e.g. the world machine building market, and that are currently heavily investing in Poland, the Czech Republic, Hungary and even Russia. This knowledge can initially be provided only through expatriate staff that train local labor force. In spite of these urgent needs, the current labor legislation in Kazakhstan makes it unpredictable for medium sized foreign companies to obtain work permits for foreign staff. Work permits are only issued within quota limits set by the Government. In 2002 this quota was set at 0.14% of the economically active population. A work permit is only issued for one year and may be renewed two times for another year for chief executive officers and specialists with higher education but not for qualified workers.
As the American Chamber of Commerce pointed out in a letter to the Ministry of Labor and Social Protection, “the unwritten message behind the Rules seems to be that foreign worker contributions are not wanted in Kazakhstan. Many (even the majority of) Work Permits are refused due to “technicalities”. Companies are spending tremendous amounts of time and money to negotiate through the process associated with the rules. Permits that are granted carry additional and unrealistic conditions, which do not take commercial reality into account.”
Unfortunately it was not possible to convince the Kazakh Government of the advantages of work permit rules applied by fast developing countries like Singapore.
The new “Law on Investments” added to the concern of foreign investors. It is very unfortunate that a law that should promote Foreign Direct Investments through offering significant incentives for investors eventually turns against an investment location. Foreign investors’ concerns about sanctity of new contracts and the right to seek international arbitrage of disputes were left unconsidered when drafting the law. The Foreign Investors’ Council, an institution representing foreign investors in Kazakhstan has been heard during the legislation process but has proven to be insignificant.
In the widely published Tengizchevroil (TCO) case Kazakhstan unilaterally changed investment conditions. TCO therefore suspended a $3bn expansion plan in November after the Kazakhstan government insisted on an accounting method that would have brought in more for the state but was not part of the 1993 contract. The TCO case was finally settled leaving a significant loss of image for the country without gaining anything in return. According to a lawyer at an international law firm in Almaty “on a practical level, state tax auditors are often using new laws that make the contracts worse.”
When reading articles in the local press and listening to speeches from politicians someone can not prevent the feeling that the Kazakhs feel betrayed by early investors and now try to regain what in their opinion has been stolen from them. This attitude does not make future investors feel more comfortable.
A complex and convoluted bureaucracy, corruption and a complicated high-cost tax system round up the picture. Registering a company in Kazakhstan can take up to half a year. The complex tax legislation and frequent changes in the legislation let you always operate in illegality, as one American businessman put it. Kazakhstan’s Transparency International’s corruption perception index is deteriorating constantly and the country is now ranked 88 out of 102 countries, leaving it worse than its peer countries Russia, Ukraine, Uzbekistan.
Although bureaucracy and a highly complicated tax system and corruption to a lesser extent also exist in Germany and investors therefore should be able to cope with it, it seems that the current level existing in Kazakhstan is unacceptable for most German investors. It is a sign of hope that even Kazakh officials address this problems openly. Kazakhstan is still a young state that received independence only in December 1991. History has proven that conditions in those countries can improve rapidly, if a capable government sees the necessity for reforms.
Ways to improve investors’ sentiment
Kazakhstan has to realize that it is-because of its geographic landlocked location and market size-not a preferred investment location as such. The current framework for Foreign Direct Investments is not sufficient to attract large scale investments outside the oil and gas sector e.g. in the petrochemical industry. 
Kazakhstan certainly has an image problem as above mentioned Transparency International corruption perception index suggests. Only countries such as Nigeria, Bangladesh were ranked worse than Kazakhstan. So should Kazakhstan worry about its image? Definitely it should, because image can make a country commercially viable.5 Kazakhstan has not yet started efficient image enhancement measures.
5. Michael F. Krause, Some Thoughts about the Kazakh Image Abroad, The Almaty Herald December 5-11, 2002
Fuller disclosure of the interest of public officials and their family members in the industry is essential not only for fighting corruption but also for creating a level playing field for all investors.
A pro-active one stop agency for investors that handles all the necessary procedures to establish a business in Kazakhstan would help small and medium sized foreign investors. In this respect it is important to mention that the one stop shop concept does not mean providing paid advice for investors but effectively handling all necessary bureaucratic procedures. The investor has to deal only with one bureaucracy.6
6. UNIDO, Guidelines for Investment Promotion Agencies
Past tax reforms have not attracted more investments outside the oil and gas sector. If the ratio of tax revenues to GDP is taken as a rule of the thumb for the tax burden within a country, the relative tax burden in Kazakhstan is 36% higher than in Russia (Tax revenues in percentage of GDP: Russia 16.2%; Kazakhstan 22.1%)7. Personal income tax in Kazakhstan contributes only 9.5% to total tax revenues. Reducing personal income tax in Russia to a flat rate of 13% has increased tax revenues from 10% of GDP to 16% of GDP following the Laffer curve. Lower marginal tax rates lead to higher tax revenues.
7. Source: KPMG Kazakhstan
An important milestone in improving business climate in Kazakhstan is President Nazarbayev’s initiative to stop harassment of small and medium size enterprises through numerous inspections by tax police, health and other municipal authorities. According to Khabar News Agency these inspections aimed at collecting bribes increased in 2002 by 19%.
Current Work Permit Rules and Procedures are the largest investment obstacle for small and medium sized investors. It is groundless to assume that foreign investors have no interest in employing Kazakh citizens. From the economic standpoint every investor will try to replace foreign workers with local staff as soon as possible. A transparent and easy to handle rule could be that foreign workers earning less than $500 are under no circumstances entitled to receive a work permit whereas those earning more than $2000 do not need a work permit. Between $500 and $2000, applicants have to prove that vacancies can not be filled from the local labor market. To prevent misuse, this income should be subject to personal income tax in Kazakhstan.
Access to visa has to be simplified. At present employees from large TNCs apply for visa at those Kazakh embassies, like Paris, that are less bureaucratic. Small and medium size companies do not have these opportunities.
These comments are not aimed at frustrating foreign investors or their Kazakh counterparts. Transforming a communist centrally planed command economy into a social and free market economy is a cumbersome process and takes time. Kazakhstan has in so far already achieved much and an ideal world for investors is not existing anywhere in the world. A first generation of new, well managed companies like Foodmaster have already been built up, but if Kazakhstan wants to diversify its economy with the help of foreign investors into more complex industries like machine building, further reforms are necessary. Diversification of the industry should be left to private entrepreneurs. State investment programs have always proven to be less efficient. The state should restrict itself to creating a favorable framework for the economy. If politicians were good entrepreneurs they would not be politicians.
After all the crucial question is, should a German Mittelstand company consider investing in Kazakhstan? The answer is clear, it should.
Numerous small and medium sized investors from Turkey, India and other countries have proven that profitable investments in Kazakhstan are possible. German investors face the challenge of bringing German business culture in accordance with Kazakh business rules. If an investor does not know these rules or does not want to adopt, investing might be difficult. In depth knowledge of the legal and tax situation is essential.
In any case return on investment should commensurate risk, i.e. an investment should pay back in less than three years.
It is always helpful for a foreign investor to know into whose local business affairs he might interfere.
Knowing how to deal with Kazakh bureaucracy is essential. Often the tax inspector showing up exceeds his power under Kazakh law. A capable accountant knows the internal rules and how to handle illegal inspections.
Recruiting capable local staff is essential for successfully doing business in Kazakhstan. Employing university graduates and training them is often the best way to achieve results. Good relationships with the leading universities might help in this respect.
Having a financial institution like the EBRD as a co-investor might be useful and offer protection. Nevertheless an investor should carefully check conditions like exit clauses, etc. under which these institutions invest.
Financing short term capital needs like working capital through local banks is extremely expensive, since banks charge up to 20% interest p.a. Interest paid on loans is only tax deductible in an amount of up to 1.5 times the refinancing rate of the National Bank (currently 7.5%) for transactions in national currency or two times LIBOR for loans in foreign currency.
Exporting to China, Iran and Russia might be an interesting option. Ispat Karmet, the largest steel producer in Kazakhstan, for example sells 55% of its products to China and Iran.
Establishing a joint venture with a local or a foreign partner is often the first step of an investment getting sour, if the joint venture partner is not selected with utmost care. A foreign investor should always be in a position to control and protect his investment. If an investor can not cover essential fields of business he should reconsider his investment rather than entirely relying on a local partner. In case foreign investors enter into a joint venture utmost care should be spend on drafting the company charter and the bylaws. In practice doubtful capital increases are a common way to marginalize partners in a joint venture and finally push them out.

Table of contents
A Summary Review of the Kazakhstan Law On Investments  Andrew Griffin, Karen Ostrander-Krug 
Tax burden in Kazakhstan  Janat Berdalina, Aigul Mustapaeva 
· 2016 №1  №2  №3  №4  №5
· 2015 №1  №2  №3  №4  №5  №6
· 2014 №1  №2  №3  №4  №5  №6
· 2013 №1  №2  №3  №4  №5  №6
· 2012 №1  №2  №3  №4  №5  №6
· 2011 №1  №2  №3  №4  №5  №6
· 2010 №1  №2  №3  №4  №5/6
· 2009 №1  №2  №3  №4  №5  №6
· 2008 №1  №2  №3  №4  №5/6
· 2007 №1  №2  №3  №4
· 2006 №1  №2  №3  №4
· 2005 №1  №2  №3  №4
· 2004 №1  №2  №3  №4
· 2003 №1  №2  №3  №4
· 2002 №1  №2  №3  №4
· 2001 №1/2  №3/4  №5/6
· 2000 №1  №2  №3

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