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Kazakhstan: Dreams of progress, but reality comes knocking

I’ve described the significant progress Kazakhstan made in improving its international standing for economic attractiveness and the recognition that it received from the U.S. government for its reform.

For much of the past 15 years, Kazakhstan was deemed by many as having the best investment climate in the post-Soviet Commonwealth of Independence States (the CIS), being second only to Russia in its ability to attract foreign investment. That doesn’t sound like much these days, given the severe recession in the Russian economy. But only a few years ago Kazakhstan was a dynamic economy aiming to join the OECD and become a top 30 economy by 2050.

I’ve also discussed a recent U.S. State Department report highlighting the significant obstacles investors face in Kazakhstan. This includes a barrage of legislative changes, non-transparent and arbitrary application of laws, harassment by various authorities through unscheduled audits and inspections, the government’s tendency to challenge contractual rights, and the tendency of courts to favor the government.

According to the U.S. State Department, “these negative tendencies feed the perception that Kazakhstan’s investment environment is subpar.”

How do we reconcile these two contradictory reports? First, that given Kazakhstan’s post-Soviet legacy and high levels of corruption, we shouldn’t be surprised at the tensions between progress and corruption.

Kazakhstan ranks 123 on Transparency International’s Corruption Perceptions Index (CPI). High levels of corruption don’t correlate with a rule of law or good investment climate, and a poor investment climate deters foreign investment (at least outside the natural resource sector) and inhibits economic growth. While the Kazakh authorities need to be applauded for the substantial efforts they have already made to improve the country’s economic attractiveness and make the country more competitive, much more work needs to be done. Unless Kazakhstan tackles its corruption problem, meeting its goal to join the OECD and become a top 30 economy by mid-century seems highly unlikely.

Perhaps it’s not fair to look at Kazakhstan the same way one would look at a developed economy, let’s say the United States, Canada, Singapore, or Norway. Kazakhstan is an emerging market, and was a Soviet republic only a generation ago. Instead of expecting Kazakhstan to abide by Western norms, it’s better to compare its performance with that of its peers.

According to TI’s CPI, out of 168 countries and territories, the CIS states rank as follows:

Georgia 48
Armenia 95
Moldova 103
Belarus 107
Azerbaijan 119
Russia 119
Kazakhstan 123
Kyrgyzstan 123
Ukraine: 130
Tajikistan 136
Uzbekistan 153
Turkmenistan 154

Kazakhstan sits near the middle of the pack. Its CPI performance isn’t terrible — it’s just underwhelming.

The problem for Kazakhstan’s leadership is that it has sold its people on the idea of constant economic progress. However, with the Kazakh tenge becoming the world’s worst performing currency after devaluing by over 80 percent last year as the result of the rout in Kazakhstan’s oil and metal exports, the Kazakh authorities will find it hard to deliver their people’s dreams of prosperity. 

With a return to high prices for Kazakhstan’s natural resource bounty uncertain, the Kazakh leadership must undertake fundamental reforms, including tackling the high corruption levels, strengthening the rule of law, and improving the country’s business climate. Only then will Kazakhstan’s government deliver the economic results the people there have come to expect.

How can American companies doing business in Kazakhstan reduce both the FCPA and local law risks from their investments and operations in the country? I’ll look at some potential strategies for mitigating the risks in my next post.

_____

Alex Nisengolts is a Chicago attorney focusing on cross-border M&A, electronic discovery, and investments and operations in Kazakhstan. He first traveled to Kazakhstan in 1994 as a legal advisor on a USAID-sponsored legal reform project and has been involved in Kazakh matters for the past two decades, for U.S. and Kazakh law firms and as a manager and senior manager for a Big Four international accounting firm. He can be reached here.

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2 Comments

  1. Very interesting posting. Perhaps we need to consider an additional factor in regard to the growth of FDI in Kazakhstan::

    As Amanda Perry-Kassaris has written, many investors prefer to invest in a state that is filled with corruption and lacks rule of law, as the outcomes are more certain there. You bribe for what you want, rather than having to take the normal risks. This is particularly true in regard to courts, – the chances of winning in litigation are usually not much more than 50% unless the judge can be bribed. That concept of bribing to win reduces risks considerably in the view of many, especially those from Asia.

    Thus, reducing corruption and bringing in rule of law is a dissuasive factor to many investors.

  2. It’s an interesting thought; however, I doubt that such a motivation applies to most companies doing business in Kazakhstan. Actually, corruption and problems with the even enforcement of the rule of law are a drag on Kazakhstan’s development, not an incentive to invest. Most of the multinationals doing business in Kazakhstan, particularly those from developed Western countries, are attracted by its substantial natural resources and would prefer a stronger rule of law, reduced corruption, and a more predictable investment climate. In many cases those companies are aware of their FCPA and UK Bribery Act risks and would prefer to avoid any instances of corruption. So, while corruption may achieve a favorable result in selected cases – e.g. obtain a government license or permit or additional business for the company – it could subject the company to significant risks that far outweigh any bribery-related gains.

    Another factor to consider is that investment decisions are largely made globally (say, in a corruption-averse North American or a European head office), while corruption is often performed locally by a local employee or agent, whom the foreign HQ has been unable to control. Faced with such risks, Western multinationals decline to invest in risky jurisdictions unless the rewards from such investment significantly outweigh investment risks. This may be yet another reason why investment in Kazakhstan was primarily made in the natural resource extraction sector, especially during boom times when oil and metals prices were high. However, with the drop in the price of those commodities, Kazakhstan has become less attractive to Western investors. Because a return to high prices for oil and metals is unlikely, at least in the short term, Kazakhstan needs to further improve its investment climate and substantially reduce its corruption level in order to attract more Western investment, especially outside the natural resource extraction sector. Kazakhstan’s government has already undertaken various efforts to improve its investment standing, as evidenced by a significant 12-point rise in the World Bank’s Doing Business Index, but so far its anti-corruption efforts have fallen short, with only a minor improvement in the CPI over last year. So, that continues to deter Western investors.

    Final thought. Please bear in mind that the above analysis describes the situation from the standpoint of Western multinationals. Investors from countries where corruption is tolerated – say, certain countries in Asia, Middle East or Latin America – may indeed seek out places where the rule of law is relatively weak in the belief that they can obtain better outcomes through bribery. However, Kazakhstan has been fighting its own anti-corruption war for quite a while and enforcement is on the rise, so corruption-friendly investors risk running afoul of Kazakhstan’s legislation, which has severe penalties as well.


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