The theme of the recent Exclusive Club of the Nation’s Top Managers was the shadow economy and the investment climate in Kazakhstan. Those participating in the meeting include: Raimbek Batalov (Forum of Entrepreneurs of Kazakhstan – FEK), Saduakas Mameshtegi (BankTuranAlem – BTA), Kintal Islamov (Astana Finance), Boris Umanov (Eurasia Insurance), Nurlan Smagulov (Astana Motors), Yerzhan Mandiev (Asia Auto), Anatoly Balushkin (Asia Auto), Tamara Omarova (Fondovny Service), Alexander Savchuk (Astana Finance, Yuri Kozlov (Development Bank of Kazakhstan), Sophia Aisagalieva (FEK), Yulia Kissidi (EuroBAK), Medet Sartbayev (National Bank of Kazakhstan – NBK), Askar Sembin (Regional Financial Center of Almaty – RFCA), Askar Urkumbayev (Financial Supervisory Agency – FSA), and Dmitri Zherebyatev (Centras Securities).
The shadow economy is inhibiting our development
First of all, I would like to give my thanks to Exclusive. Unfortunately, I was not able to participate in previous meetings, but must say that the feedback of my colleagues was very impressive. We all really lack communication with each other. In my opinion, today’s topic is very pressing, as the shadow economy is one of the reasons why we cannot develop in the way would like to and how current times require of us. It is a global problem. But, not to use existing means to solve it is simply sacrilege. Moreover, a lot of plans were developed, but they all require additional efforts. While many of my colleagues have structural suggestions on one or another issue related to the shadow economy, and it is very important to systemize them all. We have tried to do that within the framework of the “Strategic Development Plan of the Entrepreneurs’ Forum”. I hope that in a month I will be able to present it to the general public, business sector, state bodies, and financial institutions. And, I hope that it will become a basis that will be worked through to completion, and based on which concrete measures will be offered on how our businesses should leave the shadow economy. In general, the program is based on four key pillars: tax policy, customs, licensing and permit procedure, and infrastructure supporting businesses. We all know very well that our businesses will always ask for a decrease in tax rates, but at the same time the existing tax policy is really making businesses go into the shadows. The same concerns administering of customs policy. At this meeting are present representatives from the real sector, who are well aware of its “good side”. We all know the problem with Chinese imports, and this is a restricting factor for the development of entrepreneurial activity in general, due to its shadow origin. As regards the licensing and permit procedures, each of us – not only as businesspeople, but also as citizens – has come across this horrible bureaucracy that has turned into anarchy. And as for the infrastructure for support of business, this especially concerns small and medium-sized business. Of course, one of the reasons of that same corruption is a lack of knowledge among local businesspeople. Not everyone can afford to hire qualified lawyers and accountants.
I would like to add that a contradictory point of view exists, which is that we are all proud of our stability, but the basis currently is comprised of shadow businesses. As soon as the state attempts to squeeze out this part of the economy with the help of new measures, which as a rule are repressive in their character, we will all have to deal with waves of social protest. Well, this would be an extreme situation. Concerning the initial battles in the fight against shadow businesses, this has already borne its first fruit. Recently, I was told that the rates paid to those companies engaged in money laundering have sharply gone up.
To operate completely legally is nowadays mostly an issue of professional reputation
I thank Raimbek for his work. Having read articles in Exclusive, I learned that he is heading the fight against the shadow economy. In reality, the term “shadow economy” is incorrect. To be more exact, it is not necessary to “fight” against the shadow economy. A person will always be reluctant to pay high taxes. Therefore, it is better to stimulate him to leave the shadows by decreasing all fees in general, including taxes, excise payments and customs tariffs, as well as improvement of the system for enforcement of court decisions. Working completely legally is mostly an issue of professional reputation, and this motive is becoming stronger and stronger each day. We all know that many companies have at least three balance sheets. One pertains to financial accounting purposes, the next is for managerial accounting, and the third is for the bank – all this makes risk assessment on the part of banks quite difficult. However, the desire of businesspeople to decrease their expenses by paying less in taxes and through decreases in expenses for banking services can easily be understood. All of this is interrelated, and slows down the financing of the real sector. If our banking sector has significantly outpaced the real sector in its transparency, this has happened only because it had entered international markets a bit earlier. The banks understand that without transparency it is impossible to expect a decrease in the costs of external capital, as well as the receipt of better ratings, and so forth. When entrepreneurs come for credit, and ask for a decrease of interest rates and fees, they all believe that we banks have completely gone crazy by seeking such a high margin. However, the more transparent businesses are, the less the risk to us, and consequently the lower the rates will be. In Kazakhstan, many legal ways exist for paying less in taxes. Being the chairman of the Stock Exchange Council, I know that even an average businessperson can receive benefits in accordance with local legislation for a rating of A or B. Nonetheless, only advanced businesspeople utilize these benefits. Currently, our bank is preparing for an IPO, and we are carrying out a kind of tender among various consulting companies that assist in the placement of shares on the international market. Even among them one can notice the dynamics of reputation. Correctly completed documents and payment of all taxes increase the costs of any business by 15-20%. The only thing that makes me cautious is that businesspeople first come to the stock exchange to decrease their tax burden, and reputation is the last thing in which they are interested. Such types of companies will definitely attract the attention of the relative state organs. They will be the first victims of the law produced in the fight against the shadow economy. As well, if we were to speak about the development of the securities market, there should be corresponding stimuli for businesses to enter the exchanges, on which the costs of any business will be fairly assessed. Prior to coming to this meeting, I enquired of my analysts what the share of the shadow economy might be within our economy. After long disputation, they came to the conclusion that it is approximately 50%. This number should be very close to the truth. The official GDP of Kazakhstan at present does not correspond with the real volume of aggregate income, which generates additional demand for goods and services, and is creates peculiar multiplier applied to the production and trade of goods and services. This is why I believe that fighting against the shadow economy is not necessary.
Creation of any special bodies to fight against it will only create one more administrative barrier, thus worsening the investment climate. There is not doubt of this. Both the state and business need to create conditions for making production and financial activities more transparent, resulting in the increased competitiveness of the economy, as well as the entrance of local production onto the global market.
Let us control the multinationals
Since we are discussing investment possibilities, being a deputy chairman of the National Bank I am worried about the stability of the financial system prior to our entering the WTO, and define export possibilities within the subsoil sector. At present, due to the fact that banks have started borrowing cheap, long-term capital abroad, credits are already being given for the purchase of equipment. This is enough as well for the creation of capacity in the non-subsoil sector, plus the development of institutions with the goal of financing that sector. All this is well and good, but if tomorrow, speaking conventionally, the price of oil were to decrease by 30%, how would our businesses react to the shock? If we experience inflationary pressures or forex changes, what would this mean for small businesses? To what extent would the [government] declared investment projects be realized? If we consider all these possibilities, then certainly commercial banks are in quite a lofty position. As per Fitch’s reports for 2005, out of US$36 bln of external debt, we can cover only about US$10 bln. US$18 bln can be accounted for by the external debt and investment liabilities belonging to those companies operating in the subsoil sector. All these credits increase the money supply and investment pressure, which means that U.S. dollars are traded within the country and leads to the export of capital. At the same time, all these multinationals are not subject to potential regulation. When Harvard professors advised that we decrease the amount of external borrowing by commercial banks, I asked them all a question: Why do we not teach them all to regulate the activities of the corporations that are contributing to the increase of external borrowing in Kazakhstan? Therefore, maybe instead of creating a financial reconnaissance body, we had better set up a supervisory organ that would control foreign investors’ execution of their obligations? This would include their consolidated debt position. Another question that raises concern relates to the fact that deposits by nonresidents over the past three months have increased by US$800 mln. Here a question arises: If borrowing money in the West and then depositing it here in tenge brings profit, then does it make sense for commercial banks to accept such short-term deposits, creating excess risk, which can then lead to a crisis? Let us assume that one day all of them turn to the National Bank to convert their tenge back, and then some kind of emergency situation arises, which then could lead to a default or shortage of reserves. Such a situation would naturally be very sensitive for all banks that have debts in foreign currency. Therefore, this is the beginning of a game that might have some unpleasant consequences. These are two aspects that could turn into capital flight within a short period. As an outcome, both banks and companies might suffer a lot.
Easiest of all is the limitation of something: first banks, then corporations. Yet, why does nobody speak of such programs as may contribute to the development of the economy, making it larger, and enhancing the possibilities for small businesses as regards those banks and corporations. This is much more complicated than complaining about the flight of capital. The National Bank and other state bodies hope to set up a program for stipulation of domestic production, just like has already been done with the construction industry. Only then, will business win from the strengthening of the tenge.
There is one more interesting thing. Who else can win from the strengthening of the tenge? First of all, these would be the importers of the equipment, as they would pay less tenge per dollar. And, this would be purely a subsidy of the state. Secondly would be the businesspeople that have production in the non-subsoil sector. Finally, this would include that part of the population whose real income decreased from 1993-99. Now that the [current] oil crisis has brought the price up by six times, the strengthening of the tenge by 20% is one of the types of royalty payments taken from oil companies in the favor of importers of equipment and of the population. This is a signal for the market, if one has the possibility to purchase equipment, one should do so as quickly as possibly while this position lasts on the international markets.
First of all, that the National Bank is engaged in preparing to defeat attacks by speculators is comforting to know. However, I believe now is still too early to expect such a thing, as the sums are too meager. In reality, this program was not launched by the banks. Accepting deposits in dollars is more profitable, and simply cheaper for us. Finally, foreign financial investors have begun to trust the tenge following a long lapse of time. In reality, they accept a risk just because there are a lot of pressures on the tenge. For example, the oil price might drop, yet they take this risk and may profit from it. This is a normal situation. Speaking about a default because speculators have come to our market is premature.
I have a question for Raimbek. You said that the tax policy is forcing our businesses to operate in the shadows. However, the tax burden is decreasing each year. What else is needed?
We want analysts
No doubt, the tax burden has been decreasing, but unfortunately the situation is not changing. Businesses continue working in the shadow just as before. We make such short, cautious steps that no obvious results become apparent. Undoubtedly, the decrease in VAT applied to the real sector resulted in some positive outcomes – we now have additional capital, which has been directed for development. Statistics show that VAT payments did not decrease, indeed the opposite was true. However, we do not simply suggest a decrease in VAT, but the carrying out of mutual research together with the government, identifying how large such a decrease should be. We do not have an institution, like in Russia or abroad, in which good specialists work, data is processed, and substantiated proposals might be made. With regards to tax policy, here we should do research on two aspects: economic and social. Let us ask our businesspeople what they need in order to step out from the shadow. Karlygash already mentioned the rates for changing cash. We have performed a study among businesspeople, and have come to the following conclusions. If at present the cost of laundering money is from 5-10%, then businesspeople would be ready to show their revenues if the cost of official payments were at roughly the same level. But, at the same time there should be some motivation. A tax rate of 10% would be applied in those cases where income will be directed for development. Those who operate in the real sector are compelled to use their income after paying 30% in tax. This is why corporate income tax, in addition to VAT, is one of the major factors pushing businesspeople into the shadows. We are not competitive with our colleagues in corresponding industries in Russia and China. And, we will never stand on firm footing as long as almost all businesses operate in the shadows. Let us see who is to be audited by the tax inspectors. For example, 95% of corporate income tax is paid be 6% of the total number of operating companies. 10% of companies provide 80% of VAT payments. These numbers reflect the volume of the shadow businesses. However, those who work are the ones who are usually audited in our country, while those who work in the shadow are blessedly ignored. This means that we need to do everything possible so that it would be more profitable for a business to pay taxes. At the same time, we should not fight the shadow economy through the use of forceful methods. By the way, we developed our program for pushing businesses out of the shadows based on that of the Ministry of Economy. Nonetheless, that program mostly contains stick-like measures, which means enhancement of the administration process. What we vote for is giving a businessperson the carrot first, and afterwards you can use the stick.
Mutual serious research is necessary to achieve this. The same relates to customs tariffs. Over the last five years, no on has analyzed them systematically. While the situation in the market changes, and does so radically. The same problem regarding Chinese imports is also related to customs tariffs. We need to reconsider tariff policy, administration of customs, technical equipment and a decrease in the number of customs posts. The same is true with regards to licensed activities and permit issuance…
Probably, we first need to define the term, “shadow economy”. To me, it seems that optimization of tax policy does not pertain to the shadow economy. Just like prostitution and smuggling – it is part of the criminal economy.
You are absolutely right – there exists a criminal shadow economy, or illegal activities, alongside an unexposed shadow economy. Such unexposed business includes all types of legal activities, which are concealed, and the revenue from them is decreased for the purpose of paying less in taxes and social payments, as well as avoiding certain administrative obligations, such as the provision of statistical reporting. Therefore, we are considering the unexposed, but legal activities. And, in reply to Karlygash’s statement that we should not fight against the shadow economy, I would agree that there is a rationale for this. Yes, we can decrease tax rates and tariffs, but if we do not reconsider procedures to make them more simplified and transparent – meaning that if there are no reforms in administering new customs and tax policies – then the effect from the lowered rates will be insignificant. Moreover, in going through all the administrative hoops, in solving his problems a businessperson might actually see his costs rise.
We need a council of National Investors
Should our banks say that they have achieved on all the levels of transparency, of which I have no doubt, this is a merit of the National Bank. My colleagues from the CIS often acknowledge that the banking system of Kazakhstan plays the role of the locomotive for the private sector of our economy.
As a person who works both with exports and imports, everyday I run across the shadow economy. For me, its definition is quite simple – this is all the money that avoids being taxed. I can very well judge about its huge volume. As regards the automotive sector, this year more than 240,000 cars were imported into Kazakhstan, out of which 200,000 were brought in without any payment to the budget by “gray dealers”. It is clear that “white dealers” would like to make this market more transparent. However, the state’s role in it is very passive. The Russians, in comparison to us, have already strictly standardized theirs. As a result, everything that they have done greatly affects us. If in our country the ratio of legal and gray import of automobiles is approximately 13:87, then in Russia 60% are already produced inside the country, 30% are legally imported, and only 10% are from gray importers. This means that 15% of gray import in Russia versus 15% of white in Kazakhstan. This ratio is so unfavorable for our country.
With regards to legalized business, I am trying to imagine it, while taking into account our mindset: our habits of buying at bazaars, to shop for better prices… Probably, one can assess this as our backwardness. But, in such a case, we do not need all our trade centers. Let us all work at roofed bazaars, and not pay any taxes. We should not undervalue the state’s role in the fight against the shadow economy, but not in the sense of some supervisory novelty. The fact that the financial police are as corrupt as all the others is not much of a secret. The state should be in contact with business in order to work out a single legal basis [for operating] with the help of market tools. In reality, laws work against legal producers. Everybody is against us. Wherever we go we have to pay unofficially. We find ourselves being taxed twice – both unofficially and officially. At the same time, we have a great number of various ideas, which we cannot even propose to our government, which thinks that we are lobbying our interests. Because of this, we are not able to directly address them.
In principle everything is not that bad. Due to the fact that the country is dynamically developing, people would more often like to buy cars in auto showrooms more often, and the number of used cars will, one way or the other, gradually decrease. However, this process may take a very long time, like 12-15 years. Doing away with state support here is impossible. This is why I would like to speak about such things as the Council of Foreign Investors. Creating a Council of National Investors is very important for us. We have raised the interests of foreign investors too high. I myself have been witness to many scenes at meetings of foreign investors, in which the head of the country solved one or another issue within one day. As a result, in our country the attitude of officials towards foreign investors is more respectful in comparison to that for national investors. The time has come to say that we invest into our economy no less than foreign investors do, and we pay more taxes. In general, we need to place the stress on the national economy and on a national self-awareness. And, I would like to lay down a challenge for the creation of a declaration against the shadow economy. I thank Karlygash for organizing this discussion. We need to state to active investors that our citizens’ position is that we want no shadow economy in our country, and not because we are all so good and nice, but due to the fact that we all wish to be competitive. So far, we must accept the rules of the game one way or the other, and they dictate that you should circumnavigate the legal routes, and you will resolve your problems more quickly this way – and we all use these methods. Should you refuse in principle to follow those rules, you will be left out of the game. By the highest standards it is profitable for all of us if there were to be a decrease in the shadow economy. Either the state will receive US$20 bln in taxes, or all of us will go bankrupt. We all wish to pay officially, and in order to do this we all need to cooperate with the government, do something significant, and be united in associations. This is really important.
I would like to say a couple of words on the protection of gray dealers. You forgot that these are 20,000-50,000 earning their bread, and because of this they have the right to exist.
Here arises a problem of lobbying interests. There is no question about it – let us create similar conditions for everybody. As a result, we have cleaned all of Europe of its used cars, and now it is time for Japan. But who is to protect our market? For that purpose, business and the state should work together as a single corporation. After entering the WTO, if we do not take serious steps, the field for making investment will radically decrease. The WTO will remove barriers for the importation of finished products, and consequently processing industries will sharply decrease their operations. The export potential will react in a similar way. When we say that we are lobbying somebody’s interests, objectively this is true. However, does it correspond to current interests? Our plant receives many advantages, and we also apply many preferences, though, surprisingly, the size of tax payment increases on an annual basis. There is also a positive benefit to this, but the increases in tax bills are disproportionate if we are to compare gray and white supplies. If we speak about 13-15% of capital ratio as regards automotive imports, then only 50%-60% of these pay taxes. This means that the issue of administration still remains on the agenda. Let us consider Russia. At present, the structure of their imports contains 15% used cars, and so where has demand turned. Now, it is on new compact cars. A civilized network of dealers is being established, new jobs become available, service is being developed, and people are not repairing cars in their own garages as they used to do…
The point is that the process is evolving, and the market is difficult to manage. Taxes should be paid in order to create a single, competitive environment. Why does the problem of gray dealers and large suppliers appear? They work under unequal conditions. One pays only salaries, while the other pays salaries and taxes. But, what should we do with those now employed in the shadow economy? We need to provide for them the possibility of being engaged in those activities that will be more effective than simply the sale of used cars.
Specialization within the country sometimes forces businesses to remain in the shadows
If we have 9% growth in GDP, then there should also be a growth in tax revenues. Certain forces should be created in order to stimulate tax payments. Why are we not paying taxes, and why do we not participate in tenders? Because, it is difficult to win them. And, when we speak about overheating of the real estate market, nobody knows how to solve this problem. In principle, the price increase in that market has begun stimulating the production of construction materials. However, if we destroy the demand for property, then will it make sense to build plants for manufacturing construction materials? On the other hand, the state will always have the argument that it does not have enough funds, instead of creating such programs for the regulation of demand in one or another industries. The business index is one of those parameters that the state is taking as an orientation point. Such industries as real estate and construction are halfway criminal and nontransparent all over the world, and at the very least this is a closed industry. This is why we want, namely through our regional financial centers, to combine trade and financial instruments – for example, within the framework of a commodities exchange. As regards the financial market, this is like bread in a country where all the goods are exchangeable. Yet, we are lacking the exchange itself. In order to establish this scheme, we definitely should speak about some concrete programs. The first, and most important, topic is the issue of legalization. In which way will we execute legalization, and what rules will be applied after that? The second program is the development of the securities market. At present, the market does not receive clear messages as to which instruments are in demand, and this is an issue of professionalism. Currently we are protected from a crisis only with regards to gold and forex reserves, as well as the national fund. In addition, we need to establish a dualistic system using currency instruments as well. This is why it would be difficult to defend ourselves with simply the current amount of gold and forex reserves from any serious speculators on the market. Should we come together and organize certain regional standards for business, we might increase the base of issuers, which would be profitable both for banks and the issuers themselves. The conclusion is as follows: specialization within the country sometimes forces businesses to remain in the shadows. If the country were to strive for the creation of value-added products, [stable] currency, and developed instruments, then we would be a leader in the region.
Since today we are speaking on investments, I would like to remind you that according to the new law on investment, both foreign and domestic investors have the same rights. So, a foreign investor is not so fearsome as he might seem. I believe that a possibility exists, even a necessity, that the Council of Foreign Investors should include local investors as well. In such a case, it will be a truly strong and active body. I have observed the activity of this organization for over six years, and do not believe that they have ever taken any constructive measures. More than this, in working with foreigners, I practically hear everyday about how this issue should be solved by local investors. So, the issue of cooperation between foreign and local business has already become pressing. To me, it seems this cooperation will work.
The format of this meeting is quite unusual. Regarding the shadow economy, the bank itself is transparent, and to quite a significant degree. We do not have any complaints regarding this. We provide credit transparently to transparent companies. Undoubtedly, we do not loan to small companies, as this is not our field. This is the area in which we compete with other banks. Our bank is a constituent of the whole system that has been created by the state, together with customs, tax and other regulatory measures. Validation of a development bank comes from global practice. All states that try to speed up their economic modernization, as well as the diversification of their economies, have created such institutions. Thanks to such organizations, such acceleration occurs, and the banking system develops. Unfortunately, the statistics of our National Bank do not include the average credit terms of our second-tier banks. However, I can reply that the DBK has an average credit term of almost 11 years. This means more than a ten-year period.
And, what proportion of the charter capital is actually funded via second-tier banks? Really, what would be the answer? Where is the effectiveness, or the lack of it?
There will always be a dispute between a market economy and state regulation. This is what can be deemed the success of development institutions. Development organs move us one-fourth of a step closer to a market economy. In their current form they start to look like joint stock companies, as in order to be managed by a board of directors, they begin to introduce some corporate principles. No longer is it a state body. Nor, is it for industrial development. Basically, we are creating a state body to regulate those who voluntarily approach it. Of course, in the long term, the state should stick to its primary mission of gradually exiting the market. While nowadays development institutions, namely DBK, are engaged in provision of longer-term credits, moving closer to the function of the World Bank. Yet, what is negative about this? There is no clear vision of cooperation prospect between the state and business for the next ten years. As a result, we create prerequisites for competition between them, instead of doing something opposite.
I would like to add that initially when the law on the DBK was established, a different concept of the existence and development of this institution, which later on underwent significant changes. As per the initial version, competition between the DBK and commercial banks was in principle excluded, but currently it turns out the DBK creates serious competition for commercial banks, while the issue of financing long-term infrastructure projects is still under discussion.
As soon as the bank reached a certain size, a moment occurred when the concept on DBK’s entrance onto the external market was considered and accepted. However, I would like to underline that we go to the external market not only to buy, but to also contribute to the development of the chain of value-added production abroad in all processing industries as regards local borrowers. We only execute the tasks of the state. I apologize; we are not stepping on anybody.
You are not exactly stepping on someone, simply passing by. You do not notice us. We finance infrastructure projects of the city indirectly, including property development. While those companies dealing with the city’s water supply are not able to take a credit. This concerns the issue of high prices for real estate, as development of the utilities system is one of the high-cost portions of companies’ contruction costs. However, the DBK does not wish to offer funds for this purpose, and meanwhile we all dream about partnership between the state and private business.