I decided to publish my draft notes on SEZs, which I had submitted to LS magazine for publication. I think LS will forgive me, since it would be a pity for the material to go to waste :)

Special Economic Zones

One way of attracting investment in Kazakhstan is the development of special economic zones (SEZs). SEZs are governed by the law of July 21, 2011, which also defines the procedure for gaining entry to a zone. Applications for participant status are reviewed and approved by the management company.

Each SEZ has a defined list of activities that its participants may carry out. In other words, a potential investor must set up production in line with that list.

In return for investment, the state offers SEZ participants the following incentives:

1. Infrastructure built with budget funds. The state builds all the infrastructure needed for the operation of the SEZ in full and provides SEZ participants with utility connection permits.

2. Land plots for construction. Local executive bodies allocate land plots to SEZ participants for the construction of facilities.

3. Preferential access to labor. When foreign workers are hired, there is no need to first look for suitable personnel among local workers.

4. Exemption from CIT, land tax and property tax. Under the Tax Code, participants are exempt from these taxes for the duration of the SEZ.

5. Exemption from import customs duties. All SEZs are free customs zones. Goods, materials and equipment brought into an SEZ are not considered imported into the territory of the Eurasian Economic Union (EAEU) and are therefore not subject to customs regulation as imports. If these materials are processed, the new product can be brought into the EAEU without duties. Re-exports are likewise exempt from duties.

These incentives are substantial enough to matter when assessing the investment appeal of projects. But the SEZ development concept has a number of shortcomings and unfinished elements that prevent the creation of a critical mass of innovative, advanced production.

1. Legal status of SEZs. Kazakhstani legislation applies in the SEZs. A potential investor, however, will always focus on how well it can protect its interests and minimize risks. Considerable work is under way in Kazakhstan to improve the quality of the courts, but it is not yet enough, and in this respect a foreign investor would be more comfortable if commercial disputes were heard by an independent arbitration court.

The other side of the legal status is the obligation to comply with Kazakhstani legislation, especially its construction and other technical standards. Many technical regulations and requirements were inherited from the Soviet Union and do not meet international standards. Lengthy approval procedures and compliance with Kazakhstani requirements deter investors.

What is needed here is an audit and a comparison with global standards, and, where possible, permission to use international standards. To protect investments, an independent arbitration court operating under international rules should be established.

The jurisdiction of the SEZs and their legal framework are among the key problems for foreign investors deciding whether to enter a zone. Kazakhstan is a developing country, and in such countries a foreign investor's main concern is protecting its investment.

2. A complex system for managing the SEZ and its infrastructure. Too many bodies are currently involved in running an SEZ, which prevents its effective use. For example, land plots are allocated by the akimat, and infrastructure is also built by the akimat, but with funds from the national budget, so the akimat depends on the central government. Land plots are provided on short-term leases until the facility is commissioned. This makes it hard to structure project financing, because many financial institutions require the project site as collateral, and land held on a short-term lease cannot be pledged.

Likewise, the list of required documents is set by law, but it is fairly abstract and contains no clear criteria under which an applicant must be admitted to an SEZ. This leaves management companies free to set their own criteria and documentary requirements, and each SEZ takes a different approach with different requirements.

Under such a system, it would make more sense to have a single management company that would develop uniform rules for all SEZs, build the infrastructure and provide land plots to potential participants.

Bureaucracy and the lack of clear business processes for participants are among the main obstacles to entering these zones. Only when a clear operating mechanism for SEZs is in place will it be possible to talk about attracting major players.

3. Competition between programs. In the summer of 2014, amendments were made to the law on investment under which a potential investor receives roughly the same incentives as in an SEZ, but anywhere in Kazakhstan, by signing an investment agreement with the Investment Committee of the Ministry of Investment and Development. In other words, large investors lose interest in SEZs, since they will choose where to locate production based on market considerations. This competition between programs could significantly reduce interest in SEZs. SEZs need to be given additional advantages of their own, so that investors have undeniable reasons to enter them.

4. Restrictions on types of activity. SEZs in Kazakhstan are specialized by industry, so an investor is confined to the industries permitted in each zone. SEZs are currently designed mainly to attract advanced technologies and facilitate technology transfer. Attracting advanced technologies with limited labor resources is a dubious undertaking. In this context it makes more sense to develop second- and third-stage processing after the extraction or production of Kazakhstani raw materials. This is also linked to the high transport costs of delivering primary raw materials and finished products to markets, which make such production uncompetitive.

It is therefore necessary to set better quantitative criteria for entry into an SEZ, without reference to a specific industry. For example, these could cover the degree of localization of production, the share of local labor used and profitability. On the basis of such criteria, it would be easier for a potential investor to choose a line of business.

5. Financing for SEZ participants. At present the state is focused on attracting private direct investment without co-financing projects, thereby shifting all the potential risk onto private business in exchange for incentives. In the classic model this is feasible, but only in developed countries with low country risk. Kazakhstan, at its stage of development, should take on part of the risk itself, thereby reducing the risk to foreign investors, or give investors access to highly profitable industries in Kazakhstan, such as subsoil use. Yet subsoil users are currently barred from operating in SEZs, which I consider completely wrong. Granting access to subsoil resources in exchange for technology transfer could be a good way to attract large foreign companies.

Here is some more information on how the SEZs currently operate. Perhaps their results would be better if their operations were organized more or less efficiently. Publicly available information on projects is very limited.

Kazakhstan currently has 10 SEZs, of which only the one in Astana can be considered reasonably successful, because the state acted as the customer for the construction of facilities there. All the others are practically inoperative, and there is no critical mass of production. For example, not all SEZs have websites, some sites have no relevant information at all, and some have no English version.

Roughly speaking, a foreign investor who visits an SEZ's website, wants to contact someone and cannot will simply view the zone with skepticism and no enthusiasm. I would advise the Ministry of Investment and Development to at least test the feedback channels and the availability of adequate information for each SEZ.

Take the Ontustik SEZ, for example: its information is posted on the akimat's website.

That page then links to the SEZ's official site.

Going to that site, instead of information about the SEZ, we find horoscopes, humor and some chatter about language varieties. I doubt this approach will delight a potential foreign investor.

The website of the Taraz SEZ presents no information for investors at all, and the link does not work.

The Saryarka SEZ has no website at all, or I simply could not find it. One could go through every SEZ this way. To attract investors, good advertising and a good presentation of each SEZ, its incentives and its opportunities are needed.

All this points to a lack of seriousness in the approach to attracting investment. Each SEZ is limited to local entrepreneurs who use their connections to obtain information and become the only beneficiaries of the SEZs.

It would make more sense to bring in an international foreign company to manage the SEZs, one that would put their operations in order and could present information about them in a format suited to foreign investors.