THE INVESTMENT CLIMATE IN CENTRAL ASIA AND THE CAUCASUS

S .Frederick Starr

At least four separate elements define the environment for foreign investment in

the states of Central Asia and the Caucasus: natural conditions and resources; infrastructure; human resources and expectations; and governmental and legal conditions. Each of these presents a mixture of possibilities and impediments, opportunities and restraints. With the exception of natural conditions and resources, all are in a state of flux. In evaluating them, it is therefore necessary to identity not only the absolute condition in each instance but also the direction and pace of change. Among precipitants of change in the past decade, none is more important than the events of 11 September 2001 and their still unfolding consequences in Central Asia and the Caucasus.

Inherited pathologies

The reason the eight new countries of Central Asia and the Caucasus form

the subject of this analysis is that they were all formerly union republics of the USSR. Indeed, for all of them except Armenia and Georgia, their very existence as nations and states traces to political decision taken by Moscow in 1924 and 1937. It follows therefore that all of them, to greater or lesser degree, should share certain common features deriving from that common twentieth century background, and that these features, most of which can be considered pathologies, should be common to Russia and other former components of the Soviet state as well.

Any western or Japanese investor in Central Asia or the Caucasus knows these

realities well. They include a managerial class the upper ranks of which still were mainly formed under the Communist system of state property; ill-defined property rights with governmental and legal systems unaccustomed to protecting them; business practices attuned to Marxist accounting habits which, being rooted in a labor theory of value, undervalue resource inputs; powerful inter-personal networks that work informally and often outside the law; and a general lack of accountability except when top leaders intervene to impose goals.

Other pathologies existing in the eight countries under review can be traced directly to their common responses to the establishment of independence in 1991. These conditions, too, are shared to greater or lesser extent with Russia, Ukraine, and other former Soviet republics. These include the practice of strong and even authoritarian presidential rule; capricious taxation and grossly inadequate institutions for collecting taxes and adjudicating disagreements about them; wooden central banks that are inexperienced at formulating and implementing fiscal policy; primitive commercial banking systems and laws to regulate them; and poorly defined shareholder rights—especially those of minority shareholders-- that are often ignored in practice. All of these exist in a business culture that accepts rent-seeking and outright corruption as normal if regrettable practices.

Underinstitutionalization and insecurity.

Beyond these commonalities with Russia, the new states of the Caucasus and Central Asia also share certain liabilities that have no ready parallel in Moscow.

Thus, while they continue to manifest Soviet bureaucratic habits, they are all underinstituionalized in comparison to Russia. Since so many major allocational decisions in Soviet times were taken by Gosplan in Moscow, these states emerged in 1991 with only minor branch offices to handle what had become major issues in the areas of trade and investment. Institutions responsible for national banking, currency regulation, tax and tariff management, import-export regulations, diplomatic representation, and even the construction and maintenance of infrastructure had all to be created de novo. Men and women responsible for these functions had to be recruited, trained, and deployed on very short notice.

Yet more important is the fact that these eight states all entered the world under conditions that were bound to subordinate the development and management of foreign investment and trade to other issues deemed more urgent, especially the preservation of fragile sovereignties and the establishment of national security.

Repeatedly in the first decade of their existence, the new governments in the Caucasus and Central Asia followed policies that bewildered investors from more developed states, who were accustomed to taking their national sovereignty and security for granted.

Such concerns within the region were not unfounded. Like France, Britain, Spain, and other former imperial powers that were unexpectedly deprived of long-held colonies or alien dependencies, Russia was slow to adjust to the new realities, preferring instead to exert what it had long considered a proprietary right to interfere in their affairs. Meanwhile, other powerful neighbors to the east and west loomed over the region. And turmoil in Afghanistan and Iran’s unsettled political fate, along with its ambiguous relation to several of the new states, posed a constant if undefined threat to leaders of the new governments.

Surrounded by four, or possibly five, nuclear powers, a collapsed state, and a powerful NATO member, the Central Asians and Caucasus states had no choice but to view all investment and trade through the lens of national security.[1]

Differential responses to outside initiatives

Confronted by these various realities, each of the eight new states responded in its own way, based on its geopolitical location, resources, and cultural and political traditions. Formerly nomadic peoples (Kazaks and Kyrgyz) adopted relatively horizontal and open systems of governance, with their presidents only gradually assuming paramount authority. Uzbekistan and to a lesser extent Tajikistan, with their traditions of centralized power based on the control of irrigated oases, gave exceptional power to their presidents, who preside over strictly hierarchical systems. Turkmenistan’s President Niyazov, faced with powerful tribal structures but with virtually no tradition of national authority,

bent his efforts to concentrating as much power as possible in his own person.

The three states of the Caucasus all faced powerful mountain-based traditions of localism and independence, and resorted to Soviet methods to enhance presidential leadership in the face of well-organized oppositions. The management of foreign investment and trade in each case was thoroughly subordinated to these local political realities.

Counterbalancing these diverse forces have been the governments of investor states and international financial institutions (IMF, World Bank, WTO, EBRD, etc.), all of which exerted powerful pressure to bring local institutions and practices in the sphere of investment and trade into line with the practice of the prevailing market economies and the emerging global system. Parallel to the influence brought to bear by these institutional “sticks” have numerous development projects to foster the development of market economies. Thus, the World Bank beginning in 1995 funded efforts to foster investment in the oil sector in Azerbaijan and followed with an Institution Building Technical Assistance Project the next year.[2] Analogous projects have been undertaken elsewhere. In light of the fact that in September of the preceding year the Azerbaijan government had signed the “contract of the century” with western firms to form the Azerbaijan International Oil Consortium, one wonders

how critical this World Bank project was to the country’s subsequent boom.[3]

There have also been a number of officially funded investment funds, which have played the role of “carrots.” Thus, the Central Asian American Enterprise Fund was created by two acts of Congress in 1989 and 1992 and given $150 million to for the development of small and medium businesses, of which only $73 million had been invested by 2001.[4] OPIC meanwhile has undertaken an investment initiative in the Caucasus, as has the European Bank for Reconstruction and Development in both the Caucasus and Central Asia, and now the Asian Development Bank as well.

Again, the effectiveness of all these outside stimuli has been shaped by local conditions. Those countries least able to bargain—Kyrgyzstan, Georgia, and Armenia--- were the most compliant. Indeed, Kyrgyzstan became the first country of the former Soviet Union to gain entry into the World Trade Organizations. Those which saw investment in the energy sector--Kazakstan and Azerbaijan--as bringing a fast return in terms of national security moved quickly as well, and with positive results. Indeed, Kazakstan today ranks third among former socialist-bloc countries in terms of the total volume of foreign investment, behind only Poland and Hungary but ahead of Russia.[5] Those most concerned about their very survival as states –Turkmenistan and Tajikistan—were doggedly resistant to reform. While the one most concerned with consolidating national authority and maintaining social stability—Uzbekistan—chose to preserve the state’s ability to deliver social services at all cost, adopting a measured approach that minimized reform.[6]

The interplay of these various national and international factors goes far towards explaining the differing conditions for foreign investment and trade in the countries of the Caucasus and Central Asia. But they are not the whole story. In addition, one must take into account the varying realities of natural conditions and resources; infrastructure; human resources and expectations; and governmental and legal conditions in each of the eight countries under consideration.

Natural conditions and resources.

The oil and gas assets of states adjoining the Caspian are well known. Confirmed oil reserves now exceed those of the North Sea and a single find, Kashagan in Kazakstan, is the world’s largest in the last three decades. Even before the breakup of the USSR America’s Chevron moved actively to secure a stake in the large Tengiz field in Kazakstan, which it has subsequently developed successfully through the joint venture Tengizchevroil, established in 1993. In its first half decade alone Tengizchevroil invested $800 million in Kazakstan.[7] A single Caspian state, Turkmenistan, claims the world’s fourth largest reserves of gas. For the region as a whole, energy investments dominate all others, with more than $50 billion committed to Kazakstan alone. Inevitably, transport has posed greater problems than development.

The vast rusting facilities at Sumgait north of Baku attest to the death of the

large Soviet industries that formerly served the Caspian oil fields. This has opened a large field for western manufacturers and suppliers of oil field equipment, not only in Azerbaijan but in Kazakstan, Turkmenistan, and Uzbekistan. In 1999 alone the import of U.S. oil equipment and parts to Azerbaijan tripled, with similar growths thereafter.[8]

The region’s rich mineral resources were crudely exploited during Soviet times. Because of this, it has been possible for the Newmont Mining Company of Colorado to turn a profit by re-processing the tailings of earlier Soviet mining industries in Uzbekistan. While gold is productively mined in Kyrgyzstan and Uzbekistan, many other minerals, among them Turkmen chromium and Kyrgyz antimony, have yet to reach their potential. Chinese investment in the latter is now in the offing, but the shortage of foreign investment funds has hurt all aspects of Central Asian resource development except hydrocarbons.

Scarcely less important are the region’s agricultural resources. Uzbekistan is the world’s fourth largest cotton producer and second largest exporter after the United States. However, Russian colonial practice left the industry of textile manufacturing woefully undeveloped in all the region’s cotton-producing states. Recent Turkish investments in Turkemistan and a large Korean project in Uzbekistan[9] have only begun to change this picture. Food processing is also important everywhere, and dominates Georgia’s export product. Less visible than oil and gas, agricultural projects of small to moderate scale by most of the countries of Europe and Asia exert a strong and positive influence on that sector. In a related development, British American Tobacco and Philip Morris have both taken over large tracts of formerly Soviet tobacco land in Kazakstan and Kyrgyzstan, with the American firm entering into contracts with 21,000 individual farmers in Kazakstan.[10]

Due to the USSR’s extensive approach to agricultural development, a large field has opened in the post-Soviet era to foreign manufacturers and suppliers of equipment suitable for more intensive agriculture. Case, John Deere, and Caterpillar have all found niches in this large field and are all operating in more than one country in the region.

Infrastructure.

Since ships still provide the cheapest means of bulk transport, access to sea lanes remains an essential ingredient of trade and of wealth creation. While all of our eight states possess important natural resource assets, they are all located far from the major oceans, rivers, and ports. This imposes what is in effect a high tariff on every good imported to or exported from the region. The challenge to those fostering investment and development there is therefore to minimize the impact of this condition. The greatest developmental challenge in Central Asia and the Caucasus is to develop infrastructures that overcome the liability of distance and the high costs that result from it. The CPC pipeline undertaken by Chevron with Russian firms pioneered this large new field, and will be followed by the Baku-Ceyhan pipeline and possibly others.

The region’s entire infrastructure dates from the Soviet era and is rapidly deteriorating. Much of its industrial infrastructure has simply died, not to be replaced. Thus, Kyrgyzstan’s Dostan electrical engineering works was once the pride of the Soviet military-industrial complex but now is reduced to a training institute, most of the equipment having been pirated. Where it remains, old equipment imposes high operating costs, which can be overcome only with fresh investment.

The transport system is based on first on railroads and secondarily on roads. Both are oriented around regional hubs, i.e., Tashkent and Baku, which in turn link with Moscow. Transport to China, the Indian sub-continent, Iran, and Turkey remain grossly undeveloped, cutting the region off from obvious trading partners. Political factors account for many of these problems. Conflict in Afghanistan long closed Central Asia’s access to its nearest port; local conflicts prevent trade between Armenia and its neighbors, notably Turkey; while the Chechen war cut off much South Caucasus trade with Russia and Ukraine.

Only Uzbekistan and, to a lesser extent, Kazakstan, have managed thus far to update the land transport sector. True, Kyrgyzstan has reconstructed the trunk road from Bishkek to Osh but this is an exception. International and domestic carriers are rapidly improving air links, however, partially offsetting problems of land and sea access. But if these improvements facilitate contact with the outer world, they scarcely affect links among the regional capitals, which remain poor.

The development of international air routes has opened possibilities to U.S. Boeing, as well as Europe’s Airbus. American firms have not figured prominently in the reconstruction of airports, however, with the main contracts going to Germany’s Lufthansa and Turkish construction firms.

Power grids face similar problems of aging. Moreover, their Soviet design tends (as does the entire transport infrastructure) to heighten intra-regional tensions rather than alleviate them. These have become an important if often frustrating area for foreign investment. Thus, AES has invested in the Kazkakstan energy sector, but without notable success, while Uzbekistan, the region’s largest electric producer at 11,200 megawatts[11], awaits its first important American investor.

The problem of electrical power infrastructure is particularly acute in Kyrgyzstan and Tajikistan, with their immense untapped potential for hydroelectric power.

This opens an opportunity for foreign investment that for the time being remains largely unexploited.[12]

Telecommunications were also primitive, but investments in digital switches have

at least linked the capitals to the world and opened them to internet access, while investments in cellular technologies are improving communications for the middle class, but not for the rural majority. This has already opened significant opportunities to U.S. computer firms in Azerbaijan and Kazakstan, but the potentially large Uzbek market remains controlled by the Chinese-style system run by UZPAK, from which only one U.S. firm, Naytov, has succeeded in remaining independent.[13] Even in Armenia, where only 650,000 telephones previously existed, an American-Armenian venture, ArmenTel, has prospered by installing fiber optic cable, digital telephone switches, and cellular and paging services.[14]

Cellular telephone systems offer vast potential but everywhere except Kazakstan and Azerbaijan this remains largely in the future. Notwithstanding the slow start, this means of circumventing inferior Soviet infrastructure has now emerged as the fastest growing segment of the communications sector.

Human resources and expectations.

The emigration of skilled manpower severely sapped the human resource base of the entire region in the first years after independence. In Azerbaijan, Kazakstan, Kyrgyzstan, Turkmenistan and Uzbekistan it focused on Russians (and in Kazakstan and Kyrgyzstan Germans as well), but in Armenia, Georgia, and Tajikistan the émigrés included large number of the dominant nationality as well.

Emigration has been heaviest from among the educated and skilled classes.

Remaining skills are significant but unevenly distributed, with Turkmenistan and Tajikistan woefully underserved and Azerbaijan, Kazakstan, Kyrgyzstan, and Uzbekistan moving effectively in many technical fields. But skills in agriculture, the trades and crafts remain at extremely rudimentary levels.

Notwithstanding the losses, nearly all the region’s population is functionally literate and more than functionally numerate. While literacy may have fallen from levels recorded in what were doubtlessly exaggerated Soviet statistical reports, it is still comparable to the situation in developed countries. Uzbekistan leads the region (and the Commonwealth of Independent States) in the percentage of its budget devoted to education but other states are now working to reverse an early fall-off. The rise of English and large-scale programs for study abroad are rendering the region’s future business and political leadership more cosmopolitan.

While the region has been affected by several of the epidemiological scares (tuberculoses, typhus, etc.) that have swept former Soviet lands, the populations are on the whole vigorous and healthy. In spite of cutbacks in medical funding, Kazakstan and Uzbekistan have seen improvements in many health indicators, while the region as a whole has exhibited none of the demographic and health catastrophe that has hit Russia.

Governmental and legal conditions.

When the new states of the Caucasus and Central Asia were established they inherited complex systems of state orders for goods and services, debilitating licensing requirements, severe export and import quotes, and bureaucratic processes for export registration. As the economies plummeted the new governments borrowed to meet the crisis, plunging their countries into debt, building annual deficits and making macroeconomic stabilization a distant dream.

This created nearly insurmountable conditions for foreign investment and trade.

Structural reforms undertaken since 1992 have enabled all the countries of the Caucasus and two of those in Central Asia to reverse these conditions. Of the remaining countries, Tajikistan, plagued by civil war, was in no position until recently to undertake reform, Turkmenistan avoided basic reforms in it principle because of unresolved internal political problems. It still has no IMF agreement, but has privatized certain small and medium sized businesses while leaving 80% of total GDP in state hands. State owned enterprises still contribute 80% of GDP in Tajikistan, and over half in Azerbaijan, but less than a quarter in Georgia and Kyrgyzstan. Uzbekistan chose a selective and go-slow approach that also began with small and medium enterprises, as well as the leasing of land to private farmers. Until 2000 such measures proved highly successful but the slow pace of reform has now become a liability.

Kyrgyzstan and Kazakstan instituted forms early. Kazakstan had privatized all small and medium sized businesses by 1998, although a third of the economy was still in state hands in that year. Azerbaijan undertook structural reforms in 1997 with help from the World Bank. Armenia launched radical reforms only in 2000 but has since created one of the most liberal trade regimes in the Commonwealth of Independent States.

The objective of these and other reforms was to promote macroeconomic stabilization through demonopolization, privatization, debt restructuring, banking reform, price liberalization, and stable and convertible currencies. Another powerful motivation in countries seeking to develop their hydrocarbon resources is to create conditions favorable to the formation of a service sector in that sphere. In all countries a more immediate consideration fostering privatization is to raise money to pay for needed governmental services.

The desire to make each country self-sustaining in food has provided another powerful stimulus to structural reform, especially in the privatization of land.

Kazakstan and Uzbekistan have now placed nearly all of their land in the hands of private farmers under 99 year leases. Armenia and especially Kyrgyzstan have led the fifteen countries of the former Soviet Union in their boldness in transferring land to full private ownership. As a result of these actions, Uzbekistan has become self-sustaining in food for the first time in half a century and Kyrgyzstan’s agricultural sector leads that country’s growth at an annual rate of 9%.

Measuring progress

The rate of inflation provides a convenient measure of fiscal success. Azerbaijan reached 1.8% inflation by 2000[15] while Armenia reached single digit inflation two years later. Tight monetary policies in Kazakstan brought inflation down to 10% as early as 1998 and have since reduced it further. Kyrgyzstan and Turkmenistan, in spite of radically different policies and resources, brought inflation down to 20%. Evidence that Uzbekistan’s decision to avoid “shock therapy” may have outlived its usefulness is that its official rate of inflation has reached 26% and its unofficial rate as much as twice or three times that figure.

Budget deficits provide another index of macroeconomic stabilization. Azerbaijan’s consolidated deficit fell to 5% by 1999, while Georgia reduced its fiscal deficit from 20% to 5% of GDP, and its current accounts deficit from 35% to 11% of GDP.[16]

But these indicators must be balanced against foreign indebtedness, which remains at alarmingly high levels in several countries. In three of the poorest countries, Armenia, Georgia, and Kyrgyzstan, poor policies or poor advice have resulted in debts—especially to the US Export-Import Bank-- approaching $5 billion.[17] These figures are heightened in Armenia by a foreign trade deficit that reached $494 million by 1996.[18] Uzbekistan’s overall debt stands at $4 billion. Tajik debt, low throughout the civil war, is now rising precipitously.

As a percentage of GDP foreign debt by 1998 had reached 38% in Azerbaijan, 44% in Armenia, 32% in Georgia, 27% in Kazakstan, 238% in Uzbekistan, 63% in Kyrgyzstan, and 99% in Turkmenistan.[19]

Rates of growth and GDP per capita also vary widely, reflecting both the effectiveness of policies and the presence or absence of exportable hydrocarbons. Thus, high oil prices drove up Azerbaijan’s and Kazakstan’s growth rates to above 10% but are expected to settle to around 8% in the coming years. Uzbekistan’s, by contrast, is only one or two percent and possibly flat. Kyrgyzstan and Tajikistan now register healthy rates of growth but from very low bases.

As a result of these differentials, GDP per capita varies widely among the countries. Oil-rich Kazakstan is more than $10,000 and Azerbaijan would approach this if 10% of its population was not comprised of impoverished refugees from the Karabakh war. Georgia claimed more than $6000 per capita in 2000, while Armenia claimed $4900. Uzbekistan’s official figure for the same year (taking into account a weighted exchange rate) was $520, which exceeds levels for both Kyrgyzstan and Tajikistan.[20] In almost every case official figures overstate the reality.

Tax reform

No issue is more important to the foreign investor than the presence or absence of rational tax laws and moderate taxes, honest collection systems, and transparent courts for the adjudication of disagreements over taxes.

Considerable progress has been made on the first of these tasks but far less on the second and third. As a result, only Georgia (and possibly soon Kyrgyzstan) seem to be moving towards becoming low tax countries and no state in the region comes close to approaching Ireland in this regard. The reason is obvious: given their concern over need to preserve social peace and security, the governments are generally not prepared to sacrifice certain income on the possibility that lowered taxes might result in a higher level of collection.

Even in the most modernized of the region’s economies, tax reform has proceeded slowly. The obstacles to reform are formidable. In every country a welter of direct taxes, withholding taxes, VATs, and local levies to support roads and services creates a patchwork of often conflicting obligations that can result in double taxation. Thus. following Russia, VATs of 20% everywhere but in Azerbaijan and Kazakstan, where they are 18% and 16%, respectively.[21] Yet only KyrgyZstan has a sales tax, five of the countries have no road users’ tax, and only Georgia has a tax (1%) on “economic activity.”[22]

Many of the knottiest problems are purely technical. How should taxable profits be calculated? What tax exemptions should be permitted, and how should profits/losses and deductible reserves be calculated? In every case practice varies widely across the region.[23] What kind of treaty can be adopted in Uzbekistan or other countries to protect investors against double taxation? How should taxes on multinational corporations be apportioned among different countries? Systems of transfer taxes are being worked out within the Commonwealth of Independent States but these do not affect any of the region’s principal international investors.

As a result of the delays caused by working out such technical details, Kazakstan’s new tax code will go into operation only in 2002. In the meanwhile it provides tax relief for new direct investors for from two to eight years. Kyrgyzstan has led the region in encouraging free trade zones, with several operating successfully within the capital city of Bishkek and others in Osh. But its taxes on business remain onerous and complex and a completely new tax code remains a project for the future.[24] Turkmenistan has established seven free trade zones protected by a Law on Economic Zones for Free Enterprise but none is yet fully operational.[25]

In countries where nearly all revenues came from simple internal transfers to Gosplan, the creation of effective systems for collecting taxes from countless corporations and individuals is a daunting task. Thousands of people must be hired, trained, and remunerated for what are totally unfamiliar jobs involving endless temptations to abuse and corruption. Everywhere the results are predictable. In Uzbekistan, for example, greatly improved tax laws combine with caprice and the absence of transparency in their application. In this respect Uzbekistan is by no means exceptional. In Georgia as elsewhere, corruption has, in the words of the U.S. Embassy in Tblisi, “been a significant and persistent obstacle not only to foreign investment but also to economic development.”[26] In spite of recent reforms in Georgia and elsewhere, courts have yet to develop to the point that one can reasonably expect abuses to be fairly adjudicated. However, redress is often possible on a case-by-case basis by approaching political authorities directly.

Notwithstanding these Himalayan challenges, every country in the region can claim progress in the field of taxation. Tax bases have widened, receipts have increased to the point that, combined with controls on expenditure, all countries have made progress towards macroeconomic stabilization. A measure of this success has been the first steps towards the reduction of the percentage of GDP attributable to the unofficial or gray economies: from figures ranging up to 80%, the percentage has dropped to 35% in Kazakstan and under 10% in Uzbekistan. The fact that it remains at 60% in Georgia and Azerbaijan and possibly higher still in Tajikistan and Turkmenistan indicates there is much yet to be done.

Banking and stock markets

Another indicator of the receptivity of as given economy to foreign investment is the condition of its banking sector and the presence of modern commodity and stock markets. By this measure the record of countries in Central Asia and the Caucasus is decidedly mixed, although the direction of change is positive. As in Russia, banks capable of carrying out modern banking functions have been slow to develop throughout the region. Legislation adopted after 1991 led to the establishment of hundreds of private institutions calling themselves banks. With little or no capitalization and a mounting inventory of bad loans, most quickly failed. Others were closed by governmental action.

Today a main thrust everywhere is to adopt legislation increasing the capitalization requirements, which will in turn severely constrict the number of banks. In Georgia, for example, the number shrank from a high of 240 in 1994 to 27 today.[27] Most countries are following Kazakstan’s lead in forging a two-tiered banking system, with the state-owned National Bank with supervisory control over the entire banking sector, including foreign–owned banks.[28]

Meanwhile, all countries are breaking an old Soviet taboo and opening their

economies to partial foreign ownership of domestic banking institutions and to wholly foreign-owned banks. Kazakstan now allows equal foreigners to hold up to 50% of the stock in domestic banks, while permitting some twenty foreign banks (holding 22% of all banking capital) to operate there. 99% of the ownership of one of Turkmenistan’s largest banks is in Turkish hands, while all the Kyrgyz banks that have gone into receivership are available for purchase by either foreign or domestic buyers.

When Uzbekistan in 1995 constructed a large, neo-classical structure in central Tashkent to house its new stock exchange the project seemed nothing short of fantastic. Today, all countries of Central Asia and the Caucasus with the exception of Tajikistan have, or will soon have (Turkmenistan’s is under preparation) formal stock exchanges. Kazakstan’s market capitalization has reached $1.5 billion while its volume is soaring, as is turnover on the tiny Kyrgyz exchange, which now lists seventy companies. The Uzbek stock exchange saw its turnover rise by 50% in a single month, August 2001. These exchanges focus mainly on small and medium sized firms, which in Uzbekistan and elsewhere constitute the most dynamic sector of the market. In Georgia, for example, they comprise fully 84% of all enterprises.[29]

Commodity exchanges are also operating everywhere except in Tajikistan. Several region-wide venture funds –mainly American-- are now in existence, most of them buying debt and equity in firms going public for the first time. All of these fledgling exchanges suffer from inadequate access to authoritative data and market information, a problem that will only be overcome over time.

Substantial progress, uneven but very real

Progress towards creating an enabling environment for foreign investment and trade in the countries of Central Asia and the Caucasus still confronts enormous obstacles, even in those countries that moved most vigorously to achieve macroeconomic stabilization and forge essential institutions and practices.

In recognition of this reality, Kazakstan in 1998 introduced a Foreign Investors’ Council to provide a forum for investors and the Kazak government to identify and act upon problems of operation in that country. Resolutions of the Council are addressed directly to the President of Kazakstan. Among its first acts was the development of a Code of Ethics for Foreign Investors that carries reciprocal responsibilities for Kazak partners.[30]

All the impediments inherited from the Soviet past and from the first post-independence years remain in place. Heavy indebtedness hangs like an albatross on several economies, while others, like Uzbekistan, have maintained

a semblance of stabilization only through the application of draconian controls over imports, which in turn retards exports. The absence of consolidated exchange rates in Uzbekistan saps the effectiveness of otherwise impressive reforms introduced in 2000. Lengthy registration processes, unresolved tax issues, and problems of corruption continue to vex even the most promising foreign-owned enterprises. Short-term crises like the 1999 incursion of the Islamic Party of Turkistan into Kyrgyzstan’s Batken region can batter current account balances.

Nonetheless, all the economies are benefiting increasingly from foreign investments in general and United States investments in particular. The US today ranks first in foreign direct investment in Kazakstan, dwarfing second place Britain by a factor of five. Joint ventures account for a third of Kyrgyzstan’s industrial output and similar proportions of other countries. American exports to the region also lead other countries by a considerable margin. In Uzbekistan they are second after Russia and more than doubled between 1997 and 1999,[31] while in Kyrgyztan they rank second after Britain but ahead of Turkey, Italy, and Russia. Ranked in order or total value, US exports to the region area greatest to Azerbaijan, followed by Uzbekistan, Kazakstan, Georgia, Armenia, Kyrgyzstan, Turkmenistan, and Tajikistan.

In spite of the fact that fully 40% of investments in Kazkastan pertain to oil and gas, and that aircraft sales dominate the big-ticket US sales to the entire region, a process of diversification of both investment and sales is ongoing.

In every case it is safe to say that success has depended on a long-term strategy grounded in the development of enduring relationships, dogged patience, and sheer tenacity. In spite of periodic setbacks, the region-wide trends are positive for American investors and traders, and are bound to become more so as the countries persist in their efforts to achieve institutional reform, fiscal probity, and greater openness.

Implications of 11 September for investment in the region

Against this background, what is the likely impact of the events of 11 September 2001 on US trade and investment in Central Asia and the Caucasus? While it is too early to say with certainty, the following consequences are all but certain.

First, recession in the US, made worse by 11 September, will doubtless have a negative short-term impact on both investment and trade.

Second, low oil and gas prices will temporarily discourage both exploration and development in the region’s hydrocarbon sector.

Third, as the campaign against terrorism focuses increasingly on long-ignored problems in Saudi Arabia and the Gulf states it will increase the political risk of hydrocarbons from those areas and encourage the development of alternative sources for oil and gas. After Siberia, the main beneficiary of this situation will be the Caspian region. This new mood is already hastening the development of the Baku-Ceyhan pipeline and related projects, which will in turn open investment possibilities ranging far beyond the energy sector.

Fourth, the term “war on terrorism” is shorthand for many of the issues affecting the sovereignty and security of the new states of Central Asia and the Caucasus. These issues, which include Islamic radicalism, terrorism, and drug trafficking, have preoccupied every government in the region, understandably diverting valuable attention from addressing matters pertinent to economic reform, trade, and investment. To the extent that these genuine problems are diminished, the US can realistically expect the region’s governments to attend more closely and with less risk-aversion to economic needs. Moreover, the US can reasonably expect the governments to be adopt policies of greater openness, not only towards the outside world but their own populations.

Given the fact that U.S. actions in Afghanistan have addressed what every state in Central Asia and the Caucasus---as well as Russia—has identified as its main security challenge, it is inappropriate to speak of a U.S. “reward” to countries in the region for their cooperation. Nonetheless, a memorandum of understanding between Uzbekistan and the U.S. signed on 29 November 2001 signals a new American willingness to help with economic development.[32] This agreement, which provides for cooperation in the areas of power generation, fertilizer production, irrigation, transportation, and small and medium business development, will doubtless be followed by similar arrangements throughout the region. Thus, even before Secretary of State Powell on 11 December 2001 declared that American forces would maintain a presence in the region after the fighting ended, the investment climate was being dramatically altered for the better.

A vast new zone for trade and investment

The establishment of even a minimally acceptable and competent government in Afghanistan will do more than anything in the past century to overcome the core problem of distance that defines the economic fate of the entire region. Access to direct trade and interchange with Afghanistan, Pakistan, India, and Iran will vitalize the economies of Central Asia and even the Caucasus, opening new possibilities to foreign investment. Access to the port of Karachi will give the entire region a window on the world that it now lacks, reducing transportation costs and making viable many enterprises and initiatives that are now marginal, or beyond consideration.

Three measures are required to accomplish this. First, roads crossing Afghanistan that connect Central Asia with Pakistan, India, and Iran must be rendered passable by rebuilding destroyed bridges and tunnels. Second, these routes must be secured from warlords and marauders. And, third, cargo passing over them must be subject only to reasonable tariffs and imposts. When these minimal conditions are met, a new era in the economies of Central Asia and even the Caucasus will dawn.

Turkmenistan has led the region in anticipating this possibility. Throughout the mid-1990s it collaborated with Unocal and the Argentinian firm Bridas in an effort to build gas and oil pipelines across Afghanistan to Pakistan. Today these projects could well see the light of day. Even before September 11 it also proposed extending a power transmission lines across Afghanistan to Pakistan and beyond.[33] More recently it has proposed rebuilding the main road to Heart and beyond from the Turkmen border. Meanwhile, the governments of Kyrgyzstan and Tajikistan are exploring the possibility of exporting hydroelectric power to Afghanistan and Pakistan. Both are seeking international assistance in planning these projects and expect to interest international investors in the production and transmission facilities.

Other areas that will be positively affected by the opening of transport routes to Afghanistan and South Asia involve such diverse fields as civil engineering (for roads, bridges, tunnels, and airports), truck manufacturing and maintenance, hydro and thermal power equipment, highway and railroad construction, warehouse facilities including cold storage, express mail and freight services, telecommunications, airport development, air transport, construction materials, heating systems for new homes and buildings, mineral processing, stone cutting, food processing, container facilities, hydrology and irrigation systems, and training in all related sectors of the economy.

In all of these fields and many others, the opening of communication links with Afghanistan and South Asia will immediately attract investors and firms from both Pakistan and India, as well as from Iran at a later stage. Thus, the Indian firm Adjanta Pharma, Ltd., has already built a pharmaceutical plant in Turkmenistan, investing $2.5 million in the project,[34] while the National Bank of Pakistan has opened branches in Kyrgyzstan and Tuirkmenistan.[35] American enterprises would be well advised to work through their local branches in India and Pakistan or to collaborate with firms there, rather than always seek to enter this new market directly.

Discussion of the impact of September 11 on Eurasia to date has been limited mainly to the possibility of ridding the region of obvious evils. Far less attention has been accorded to positive developments that might arise thereafter. But if the picture presented here is correct, then the coming decade will see the reemergence of a historic trade and economic zone compromising former Soviet Central Asia, Afghanistan, eastern Iran, Pakistan, and northwest India, and with close links to both the Caucasus and Xinjiang in China. The reemergence of this region, which for 2,500 years was understood to be the true “Central Asia,” will mark an epochal change in the world economy and open unimagined prospects for international trade and investment.

[1] Charles H. Fairbanks, Richard Nelson, S. Frederick Starr, Kenneth Weisbrode, Strategic Assessment of

Central Asia and the Caucasus, prepared for the U.S. Joint Chiefs of Staff, Washington, 2001, Executive Summary.

[2] Regional Overview: Azerbaijan, The World Bank Group, 2001, p.3.

[3]By contrast, World Bank initiatives in Armenia, Georgia, Kyrgyzstan and Tajikistan have played an undeniably important role in economic development.

[4] Annual Report, The Central Asian American Enterprise Fund, Washington, 2001.

[5] “Request for Market Economy Status for the Republic of Kazakhstan,” Kermit W. Alstedt to Secretaryt of Commerce Donald L. Evans, 28 June 2001, p. 10.

[6] Uzbekistan’s relative success in this endeavor is detailed in United Nations Human Development Report 2000: Uzbekistan, New York, 2001.

[7] Theodore J.Kim, Central Asia and the Caspian,: Open for Growth, Euromoney Books, 1998, p. 108.

[8] Derek Nowek and Kelly Raftery, “A Glimpse at US Exports and Imports in 2000,” BISNIS, U.S. Department of Commerce, p.1.

[10] Kim, Central Asia and the Caspian: Open for Growth, p.109.

[11] Country Commercial Guide: Uzbekistan, 2002, U.S. Department of Commerce, p.2.

[12] Country Commercial Guide: Kyrgyzstan, U.S. Department of Commerce, 2000, p.1.

[13] Country Commercial Guide: Uzbekistan, U.S. Department of Commerce, 2002, p.2., p.7.

[14] Country Commercial Guide: Armenia, U.S. Department of Commerce, 1998, p.4.

[15] Rupinder Singh, “Economic Outlook, Azeeribaijan: Mid-Term Horizon to 2005,” The Economist Intelligence Unit, 2000, p.5.

[16] Kim, Central Asia and the Caspian: Open for Growth, country overviews.

[17] Bloomberg News, 9 March 2001, “Former Soviet States Deep in Debt After Decade of IMF Support,” p.2.

[18] Country Commercial Guide: Armenia, “Armenia’s Commercial Environment, 1998, p.3, U.S. Department of Commerce, 1998.

[19] All figures from World Bank country reports, 2000.

[20] All figures from U.N. Statistical Handbook, 2001.

[21] The Taxation Systems and Economic Development in Select Countries of Eurasia, Douglas Townsend, ed., International Tax and Investment Center, July, 2001, p. 19.

[24] Country Commercial Guide: Kyrgyzstan, U.S. Department of Commerce, 2001, p. 1.

[25] “Investment Climate,” Country Commercial Guide: Turkmenistan, U.S. Department of Commerce, 2000,p.5.

[26] Investment Report, U.S. Embassy, Tblisi, 1999, II, p.12.

[27] “Georgian Banking System,” Interfax, 25 August 2001, p.1..

[28] Doing Business in Kazakstan, Baker and McKenzie, Washington, 2001, p. 41.

[29] Small and Medium Enterprises State Support Concept, Ministry of Economy, Industry, and Trade of Georgia, Tblisi, 2001, p.1.

[30] Ernst and Young, Kazaktsan Investment Profile, 1999, P. 10.

[31] “Uzbekistan is a “bright spot” in 1999 for U.S. exports,” UzReport.com.reviews BIZNIS Report, 4 April 2000.

[32] “U.S. and Uzbekistan Sign Memorandum on Economic Cooperation,” U.S. Trade and Development Agency, 3 December 2001.

[33] Country Commercial Guide: Turkmenistan, U.S. Department of Commerce, 2000, p.2.

[34] “Investment Climate,” Country Commercial Guide: Turkmenistan, U.S. Department of Commerce, 2000,p.12.

[35] Country Commercial Guide: Kyrgyzstan, U.S. Department of Commerce, 2000, p.5.