FDI’s Life in Kazakhstan
Analysis of statistical data shows that the launch of the PAIID (Program of Accelerated Industrial and Innovative Development) definitely helped to attract foreign direct investment in the manufacturing sectors of the Kazakh economy. However, the policy of developing high-tech industries and services will require from the government the reconsideration of trade and investment policies. Otherwise, all our attempts to globally climb the value added chain will unlikely succeed.
In its economic policy Kazakhstan has always adhered to an active cooperation with foreign companies, and thus, it is not surprising that over the past two decades the FDI inflows have steadily showed an upward trend in terms of volume and growth. Moreover, this process can be divided into two main stages. At the first stage, in 1992–2008, our country had managed to use its advantages in the area of natural resources to the maximum and attract investment in the oil and gas and uranium industries, the financial sector, and partly in the production of building materials and food. According to estimates of the Ministry of Industry, during the said period, 51 large investment projects with participation of transnational corporations were implemented in Kazakhstan.
Along with that, the global economic recession that had caused a sharp drop in commodity prices clearly demonstrated that to ensure sustainable development, the country should focus on strengthening the manufacturing sector’s role. As a result, in 2009 the government adopted a policy of accelerated industrial development, focusing on attracting transnational corporations who are interested primarily in implementation of non-raw material investment projects. This qualitatively new stage required a major revision of the investment policy, as well as creating a more favorable legal and regulatory framework. For the projects proposed in the priority sectors of the economy the legislature provide for the grants in kind and the exemption from customs duties in the import of completing parts, raw materials and spare parts. With this, the strategic investors were promised exemption from land and property taxes for a period of 7 years, as well as reimbursement of expenses for gas, electricity, acquisition of land, buildings and structures.
To ensure the system work with so-called "iconic" transnational corporations, the National Plan to attract investment was adopted. In its framework the six priority countries for location of the said companies were selected: Germany, France, USA, Japan, South Korea, and the United Kingdom. A single chain of supporting investors was built, involving diplomatic missions of Kazakhstan to specialized support centers established at regional Akimats.
Rankings in the top international rankings, assessing the investment climate, have significantly improved Kazakhstan. For example, last year the country ranked the 50th in the world on the ease of doing business, 33rd on tax burden, and 10th in terms of investor protection.
According to statistics, the result of all this work by the government is as follows: Of $183.922 bln of investment made in Kazakhstan's economy in the last nine years, $101.785 bln, or 55.3%, was raised precisely in the period from 2010 to 2013, i.e. during the implementation of the PAIID. Over these four years, gross inflows of FDI in the manufacturing sector had increased by more than twice. The greater part of investments was made in the mining sector, mechanical engineering, chemical industry, as well as in the production of building materials. In addition, FDI for the first time was made in high-tech industries, such as pharmaceuticals, PCs, electronic and optical products.
Today, more than 300 investment projects are under the control of the Ministry of Industry, including 110 projects, totaling $20.6 bln, which are already implemented, 98 projects currently under implementation ($44.7 bln), and 131 prospective projects ($33.6 bln).
And yet since the first stage, when investments were mainly made in the commodity industry lasted quite a long time, we can hardly expect a rapid correction of such imbalances. In the total FDI’s structure attracted in 2005–2013, 58.8%, or $108.2463 bln were invested in the commodity sector of the economy, including 33.4% ($61.5162 bln in geological exploration and prospecting, and 25.4% ($46.7301 bln) in production of minerals primarily hydrocarbons. With this, the share of manufacturing industries alone accounted for 11%, or $20.1963 bln, with the lion's share of these funds invested in metallurgy, where Kazakhstan cannot yet boast a higher value-added level of products in the value chain. Investments by foreign companies in trade do not exceed 8% ($14.8765 bln), financial activities – 5.9% ($10.8929 bln), construction – 3.6% ($6.6919 bln), the sector of information and communication – 2% ($3.7206 bln), transportation and warehousing – 1.4% ($2.5554 bln), and electricity, steam and water supply – 0.9% ($1.5635).
Geographical structure of the gross inflows of FDI has not practically changed. So, of 123 countries that are at the moment the investors of Kazakhstan, the major are the Netherlands – 27.6% ($6.7 bln in 2013), the U.S.A. – 10.1% ($2.4 bln), China – 9% ($2.2 bln), Switzerland – 8.4% ($2 bln), and Russia – 5.4% ($1.3 bln).
Need a fresh breath
Last year turned out to be not successful in terms of gross FDI inflows – the record $28.9 bln received in 2012 followed by a sharp decline by 16.6% to $24.1 bln. The first signs of the decreasing activity of foreign investors in the manufacturing industry, where their investments fell from $3.4 bln to $2.8 bln, arouse special concerns.
Today, when Kazakhstan is on the threshold of the second five-year period of the PAIID, the priority of which is the development of high-tech industries, such as pharmaceuticals, renewable energy, transportation and logistics, information and communication technologies, as well as mechanical engineering, any slowdown in investment is a significant risk. It is not a surprise why in the beginning of the year during an extended session of the government, the President paid a great deal of attention to improving the investment climate. "We need to establish clear, transparent and predictable rules. What do investors want? They are interested in a number of basic factors: stability of the contracts and legislation, social stability, infrastructure, energy, transport, labor force, and easy visa regime. We have all that, but it does not work well, and even if it works, it doesn’t work for the benefit of the investors."
As the practice of implementation of investment projects has shown, foreign companies often face problems related to land, taxation, the issuance of visas, work permits, and the customs legislation. In this regard, President Nursultan Nazarbayev instructed the government to consider the possibility of a radical reduction of administrative procedures in the conduct of foreign trade, so that the passage of any goods through the customs border of the country would take not more than 3 days. One more task is to update the National Plan and to introduce a new package of incentives for investors with investment agreements serving as the basis.
"We have to ensure the stability of these agreements and contracts. Investments come to those sectors of the economy which have less costs and a high potential for industrialization... The goal of industrialization is not a collection of disparate projects, but the development of a strong manufacturing sector. The government should have a clear plan how to attract foreign and domestic investment. For each priority sector of the economy it is necessary to determine the list of top multinational companies and to develop strategies to attract each of them. The government needs to begin particular work with leading companies for the manufacturing of oil and gas and mining equipment and farm machinery, and to deal with the investors who are ready to set up productions in Kazakhstan and support such investors in every way."
The President expressed such his position in February, and later in April the Minister of Economy and Budget Planning Erbolat Dossaev informed that by June the government of Kazakhstan was going to submit to the Parliament a draft law to improve the investment climate. Within its framework, they are going to introduce a new format of investment contracts, which will have provisions ensuring the measures of state support as compensation by the State of to 30% of the costs after the commissioning of the facility, the exemption from CIT, long-term orders for goods and services of investors from national holding companies, as the main drives to attract "iconic" transnational corporations. In addition, it is planned to implement the principle of "stability" in the tax and environmental laws for a period of 10 years, as well as to introduce the institution of investment ombudsman.
Moreover, in order that transnational corporations could predict their production costs, a program of tariff policy with regard to natural monopolies until 2020 will be adopted. It provides for the transition from short-term to long-term regulation through the adoption of maximum tariffs for services of natural monopolies with a validity of 5 years or more.
According to the government plans, in the second five-year period of industrialization, the special economic zones (SEZs) are seen to be the main points of growth. Their potential in raising foreign investment has not been revealed yet to the end. The main problem of the effective development of Kazakh SEZs is the lack of a strong connection with international markets limiting their participation in attracting FDI and large, respectively, advanced technologies.
In order to bring the SEZs to a new level in 2014, the government intends to approve the draft General Plan of Development, Advancement and Management of SEZs, subject to the requirements of the concept of the second five-year period and the cluster policy. It is planned to modify the relevant legislation and to create a single operator of the SEZs with attraction of a strategic partner.
By building up its investment policy, Kazakhstan should certainly take into account global trends. It is quite interesting therefore, that in the findings of the World Investment Report 2013 promulgated by the UN Conference on Trade and Development (UNCTAD), it is noted that in 2012 global FDI inflows fell to $1.35 trillion, which is 18% less than in the previous year and one and a half times lower than the pre-recession level of 2007. In the group of developed countries, FDI dropped by 32% to $561 bln, and in the EU by 42% to $259 bln. The main reason for the decline of FDI was the uncertainty caused by the continuing recession in the Eurozone and political instability in some countries. In those circumstances, many transnational corporations instead of foreign investment gave preference to a temporary strategy of accumulation and the consolidation of their holdings. Analysts believe that in the case of improving macroeconomic environment and restoring investor confidence they could expect that the transnational corporations would use their record high holdings for new foreign investment. In this case, global FDI inflows could rise to $1.6 trillion in 2014 to $1.8 trillion in 2015.
For developing countries, here the FDI inflows decreased by only 4% to $703 bln. It is noteworthy that in 2012 they had leading positions in attracting foreign capital and at that time for the first time had outstripped the developed countries in terms of aggregate FDI.
Along with that, the UNCTAD’s report highlights a certain way back from the disinvestment processes, i.e. repatriation of multinational companies earlier established abroad. Thus, a number of American companies have already moved back to the U.S.A a portion of their productions from China, India, South Korea and Hungary. Most of these decisions were made, following the fall of the attractiveness of a cheap labor force due to automation, as well as a desire to ensure a reduction in transport costs and proper control over product quality.
The latest trend is particularly noteworthy given the fact that the dominance of global production systems (GPS) is very typical for the world economy today, when the trade in intermediate goods and services serves manufacturing processes, fragmented and separated between countries. GPS is usually coordinated by transnational corporations, and international trade in semi-finished and finished products is carried out within the network of the branches, contractors and independent suppliers of these transnational corporations. In general, the share of GPS under the control of transnational corporations is accounting for about 80% of world trade at the moment. In this situation, the extent of participation of a particular country in GPS directly affects the value added, set by its national economy, as well as the unemployment and income of the population. Cooperation with transnational corporations can bring increased productivity through technological improvement and training, as well as new opportunities for long-term industrial upgrading. For example, exactly this integration into global chains enabled China in the last decade to develop high-tech export-oriented productions and increase eightfold the export of knowledge-intensive services.
However, participation in the GPS is associated with a number of risks, as technology transfer and productivity growth do not happen automatically and require considerable investment. It can happen so that a country is locked in a low-income segment of the global supply chain. The economy can also face negative effects from the worsening condition of the environment. Thus, the export productions worldwide in 2010 alone emitted into the atmosphere 8.4 bln tons of carbon dioxide, or 27% of the total volume of emissions. The downward trend in the unemployment rate may also be unstable, because integration into the GPS occurs mainly due to the coming to the market of transnational corporations, which primarily seek to maximize their profits. This means that they can quickly move the production to a country with cheaper labor. With this, the participation in global supply chains by branches of transnational corporations rather than the countries themselves creates the problem of transfer pricing and withdrawal of profits from a country when the country refers to the "intermediate link of the supply chain".
However, the contribution to the setting of added value of local firms involved in the chains can be quite significant, the same as the volume of reinvestment of earnings carried out by branches of transnational corporations. In order to overcome the above-mentioned risks, it is necessary to develop special programs of "painless" integration. In circumstances when transnational corporations decide themselves which country they will include in the chain, the key factor here is the level of transaction costs. The cost and the conditions of imports are also of no less importance than the export and its terms, since protectionist measures in principle are very harmful and negatively impact the foreign suppliers and local producers. In this regard, UNCTAD experts recommend ensuring the synergy of the policies in the area of trade and investment, the lack of interaction between which often results in a counterproductive effect.
Special attention should be paid to the development of the services market that support and advance the production. This concerns transport, energy, telecommunications, logistics, financial and professional services. In recent years, more and more is said about the emergence of these services, which are themselves the link of the added value chain. A striking example is the development of an outsourcing and back-office sector in India. Today, much of the value added in the world generates due to services rather than production: it lies in the intellectual property, logistics and marketing, etc.