Among the 27 countries of Eastern Block Countries making the transition from Communism to Capitalism, Uzbekistan remains one of the laggards of transition and pro-market reform. The root of the Economic and Political Problems lay in the government’s tight grip and President Karimov’s Dictatorial Regime. Whether Economic or Political, the chances quickening any reforms in Uzbekistan are not good, solely because the President and his government favours administrative/totalitarian, rather than market/democratic solutions.

Although the constitution guarantees many rights and freedoms, the regime is, in effect, an autocracy. All the important aspects of policy initiation and implementation are controlled by the President, Islam Karimov. The unicameral legislature is entirely composed of yes-men, and the judiciary has no independence from the executive. Breaches of human rights are routine, as is the repression of the opposition by the National Security Services.

The government comprises two separate tiers. There is a central government, the Council of Ministers, which de facto serves as an implementor of presidential decisions. There is also one plenipotentiary prefect (hakim) per region, who is selected by, and reports directly to, the president. At both levels, a major function of government officials is to serve as political fuse for the president, who regularly disposes of them to account for his own policy failures.

All the parties with seats in the 250-strong supreme assembly (Oli Majlis) are pro-government. The ruling party is the ex-communist People’s Democratic Party. Some parties in parliament (pro-government groups such as the Social Democratic Party Adolat (Justice) and the Vatan Taraqqieti) claim to form an opposition, but they are government-sponsored. All real opposition parties are banned. They include:

• Popular Movement of Uzbekistan Birlik (‘Unity’) – first organized and most powerful democratic organization in Uzbekistan, led by Abdurahim Pulat, currently resides in the US.

• Erk (‘Freedom’) Democratic Party – organized by President Karimov on the base of splinted from Birlik group, 1990, led from exile by Madaminov Salay (Muhammed Solih). After presidential elections of 1991 moved to the opposition.

• Islamic Movement of Uzbekistan (formerly Adolat (‘Justice’) group) - an Islamist party with strong position in the Ferghana Valley. Adolat was suppressed in 1992 and its leaders have fled to Iran and Afganistan and most members jailed. Led by Tahir Yoldash

The next elections to the Oliy Majlis are scheduled for December 1999. President Karimov was first elected in 1991 and was due for re-election in 1996. However, through the referendum held in 1996, he "extended" his term of office to 2000. It is not clear yet if next Presidential Election will be held in 2000. Observers believe that all elections since independence have been rigged and subject to full irregularities.

Since the independence, Uzbek Government and President Karimov fully conducted internal policy oriented to the strengthening his dictatorial regime. At the same time foreign policy has been inconsistent during this period on the following grounds:

1992-1994: Russian oriented policy.

1995-1996: Attempts to turn more to the West oriented policy in the hopes to get financial support. During this period, relations with the US were warm, and the European Commission signed a Partnership and Co-operation Agreement (PCA). However, 1996 turned again to the negative direction. Relations with the IMF broke-down and the country’s Stand-by Arrangement loan was cancelled. The European Parliament refused to ratify the PCA on the grounds that human rights violations and control over the currency convertibility issues. The US also started reconsidering its position on Uzbekistan as its main ally in Central Asia.

1997-1998: Russian oriented policy. From Karimov’s point of view, Russia has the advantage of not questioning the country’s democratic credentials. Furthermore, Russia has the same fear of Islamic extremism as the Uzbek leader, and would therefore be a "highly probable" ally in the event of an extremist wave.

1998-1999: More serious attempts to become more closer to the West, primarily with the United States, order to get more financial support, because of catastrophic economic situation and withstand against possibilities of Russian-Tajikistan defence alliance.

Bomb attacks in the capital have damaged Uzbekistan's image of relative domestic stability. Tensions with Tajikistan and other regional states have added to concerns about stability.

There is a growing rumours that Karimov alienates a grouping of powerful government officials, business interests and security forces, and that such groups could build serious, and successful coup against him.

President Karimov’s regime has several major characteristics:

• Statism: the state still owns a very large proportion of the land and the economy. Its revenues and expenditure account for much of the GDP. Even the fledgling domestic private sector is, in effect, under state supervision. Market forces, especially when involving foreign investors, are considered with suspicion.

• Flux: in order to preserve and consolidate his own power, Karimov keeps sacking top officials, be they ministers or regional hakims. As well as keeping any challenger from rising through the political hierarchy, this serves the function of shifting blame for policy failures away from the President.

• Paranoia: following a communist tradition, Karimov considers Islamic extremism to be the greatest threat to the integrity of Uzbekistan. This (as yet largely unfounded) secular fear motivates the heavy-handed suppression of Islamist groups, particularly in the strongly Islamist Ferghana Valley.

There are substantial ethnic Uzbek minorities in Afghanistan and Tajikistan, where there have recently been civil wars with Islamic extremist forces. These minorities were encouraged to fight on the more secular side. In Afghanistan in 1997 this backfired when the fundamentalist Taliban movement temporarily managed to conquer most of the territory and reached the border with Uzbekistan. In Tajikistan too, the strategy did not pay off, and a broad coalition that includes Islamist forces now governs the transition to peace. In both cases, Tashkent has been eager to prevent conflict from crossing its borders, but its meddling has actually been counterproductive.

There are also significant Uzbek minorities in Kyrgyzstan and Turkmenistan. Whilst this is not currently causing any friction, future tensions cannot be discounted.

President Karimov is likely to run for a (probably rigged) re-election in 2000. Failing a palace coup, of which there are no signs, the potential for change comes from two factors:

• Given the state of the country, reform cannot be deferred forever. If it is, successive policy failures will lead to something having to give. Consequences could take the form of massive social unrest, a strengthening of the opposition or of clan rivalries, or a coup.

• The leadership’s fear of Islam, largely unfounded at first, may develop into a self-fulfilling prophecy. Already, repression has radicalised Islamists led by Tohir Yuldosh: a splinter of the suppressed Adolat movement formed Islom Lashkarlari (‘Islamic Troops’) and joined the Islamist opposition in the Tajik civil war. A series of destructive blasts in Tashkent city centre in mid-February, may have been connected to Islamic Extremism.

It seems the Government have understood its future very well. At the same time it seems the Government is not going to change its general policy – strengthening of executive power continues to decrease the role of legislature and judicial power, restraining of democratic developments, neglecting the international human rights norms. In order to justify its policy the government try to exaggerate the threat of immaterial Islamic fundamentalism in every possible way. Without any doubt the bomb blasts in Tashkent, February 16, were very useful for official Uzbek propaganda. Taking into consideration these circumstances Uzbek opposition, especially Birlik put forward suggestion the blasts were organized by security service agents of Uzbekistan.

Total net FDI (1996): US$84m (inflows have slowed down considerably since then)

Main investors: Turkey, US, South Korea, Indonesia, UK, Germany, Japan

Major export products: Cotton 42%, fertilisers 40%, gold 15%, energy 7%, non-ferrous metals 5% (1997)

Major import products: Machinery and equipment 40%, foodstuffs 23%, minerals and chemicals 13%, transport equipment 9% (1997).

Agriculture is the most important economic sector. It generates around 20% of GDP and employs over 40% of the workforce. The bulk of agricultural output is accounted for by cotton, which also drives part of the country’s light industry and is the country’s main export earner.

Another major export is gold, mostly from a giant Muruntau mine in the province of Navoi. Like cotton, gold production has seen a decline in recent years. Other exploited mineral resources include silver and copper, but their GDP portion is very small.

Industry as a whole accounts for around 18% of GDP and 13% of the workforce. It is seen that industry will be declining because of the lack of the clear mass privatisation policies of Uzbekistan Government. Recent delays of privatisation and lack of interest to big industrial facilities such as Chkalov Aircraft Factory and Almalyk Metallurgical plants are good examples of the Uzbek style privatisation.

The energy sector is growing, due to a government push to achieve self-sufficiency. Apart from the energy sector and a few foreign direct investments, industry is mostly centred on agricultural machinery.

Figures for services’ share of GDP are unreliable, but it seems that they remain largely undeveloped.

The state sector remains extremely large, although figures are deliberately misleading. There is also a large ‘grey’ economy.

Like most other republics of the former Soviet bloc, Uzbekistan was struck hard by the disintegration of the USSR. It was left with none of the subsidies it used to get from Moscow and an economy over-dependent on cotton production and gold extraction.

In 1994, Uzbekistan agreed its first IMF-backed stabilisation programme. This led to measured trade liberalisation. However, the country soon failed to deliver on key aspects of the programme, such as current-account convertibility for the Som. In 1996, this was compounded by the reintroduction of old trade controls in the face of bad harvests and low commodity prices. As a result, the IMF withheld its support. The President, meanwhile, declared his country was following its own ‘unique’ path of development, on a statist Asian model.

The reputable Economic Intelligence Unit predicts that foreign direct investment is likely to remain at low levels or will be cut back by major Corporations as the government continues its largely isolationist Economic policies. Examples are the major players such as Enron, Unocal and AIG have all substantially cut back on operations in Uzbekistan. Even Uzbekistan strategic investor fell far short of its production targets, and it is understood that Uzbekistan is not offering attractive terms of sale.

Yet foreign investors in the country have faced some tough problems in recent years, and particularly since late October 1996 when promising advances towards the creation of a free market soured with a series of measures tightening state control. Though not suffered by all foreign investors, the problems faced by some have included:

• unpredictable delays in the processing of currency conversions;
• an evaporation of the purchasing power of their worker's wages;
• much cumbersome paperwork related to the control process;
• the imposition of an obligatory conversion of 30% of hard currency accounts; and
• the creation of an accounts payment system which has severely hampered domestic funds management.

It seems clear that these measures, taken collectively, have dampened foreign investment in Uzbekistan. Several significant investments under study have been put on hold because of these policies. Other investors active in the country have been constrained to reduce the pace of their investment with hopes that Uzbek policies in the area will change.

Structurally, the economy has not evolved any "true" independence. The main differences are a growing black market, a weak private sector and a number of joint ventures with foreign companies. Great swathes of the economy are still in state hands, including the banking sector. The centralised ordering system for agriculture, goszakas, remains in place. In addition, the Central Bank (CBU) has no independence whatsoever.

Karimov has been trying to achieve several goals, including self-sufficiency in grain and energy, weaning the economy off cotton, and import substitution. These goals have been pursued by means of largely incoherent statist methods, and the results have been mostly negative. In particular, the economy’s overdependence on cotton is, in fact, being encouraged by ISI, which is largely funded from cotton proceeds. In turn, ISI subsidies are acting as a shield protecting uncompetitive domestic enterprises from the outside world and preventing the development of a lean domestic sector.

Profitable domestic private enterprises fall mainly into two categories: those in the black-market and those managed by protégés and relatives of the government.

Following independence in December 1991, the government sought to prop up its Soviet-style command economy with subsidies and tight controls on production and prices. The country’s lack of economic development is largely a result of presidential politics. Karimov is suspicious of market forces. Furthermore, statism enables him to remain in control of the country and prevent the rise of constituencies that might oppose him. In this context, there are two possible agents of change:

• Firstly, if Karimov were to meet more political opposition or be replaced, economic policy might change. This would not necessarily lead to free market reforms, but, at this stage, any change would probably be positive, towards democracy.
• However, more importantly, economic crisis itself is going to put a lot of pressure on the President to make concessions, if only to receive IMF money again. After all, social stability remains Karimov’s key concern. Prolonged lack of reform can only increase the risk of economically motivated unrest. Thus, in late 1998, the cash-starved government announced emergency sell-offs of state assets for 1999/2000 in the wake of an acute economic crisis.

In the short term, the economy will continue to experience strong pressure from the fall-out of the Russian economic crisis and low commodity prices.

Most importantly, foreign investment is low and will even be lower if government keeps statism and isolationist policies, and foreign reserves highly depleted. Medium and long-term debt has been rising and mostly short term debt is also very high. The debt problem obviously mainly related to the foreign investors confidence to the economy of Uzbekistan and poor relations with IMF. Although Government has been talking about IMF mentioned reforms, there is a very little indication that it is willing to make necessary changes to open up IMF funds.

The Uzbek legal system is based on civil law. A new two-part civil code was introduced in 1997. Other codes include the Criminal Code, the Labour Code, the Civil Procedure Code, the Customs Code etc. Presidential decrees also play an important part in the evolution of the system. Investment-relevant laws include:

• The 1991 Law on Denationalisation and Privatisation, which governs privatisation.

• The edict On Additional Measures for Development of the Security Market, which created the state commission on securities and the stock exchange (SEC).

• The 1996 Law on Joint-Stock Companies and the Protection of Shareholders´ Rights, which governs the form and rules of the main corporate vehicles.

• Two May 1998 laws, which extend and improve previous foreign investment legislation: the new Foreign Investment Law (FIL) replacing a 1994 version, and the Law on Guarantees and Measures of Protection of Foreign Investors´ Rights.

Whilst on paper the system has travelled some way from its Soviet past, legal transition is still at an early stage. Bureaucracy and the judiciary’s lack of independence mean that, even when the laws are satisfactory, the rules are not necessarily set in stone. Furthermore, the regulatory environment for foreign investment remains too complex and restrictive. And de facto, certain types of investment, such as portfolio investment, are unlikely due to the immaturity of the stock exchange.

In principle, the 1998 FIL guarantees foreign investments against nationalisation and expropriation, except in cases of natural calamities, accidents and epidemics´. In such cases, investments may be subject to requisition in return for compensation. The FIL also protects foreign investors from legal change for a period of 10 years from the date of their initial investment.

Commercial disputes involving foreign investors can be settled either by international arbitration (if the parties have agreed on this) or by an Uzbek commercial court. Uzbekistan is a party to the 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards. In the case of disputes with the state, the country is also a party to the 1965 Washington Convention, so that arbitration can be sought from the International Centre for Settlement of Investment Disputes (ICSID). Outside the framework of these international agreements, foreign judgements are generally not recognised in Uzbekistan.

On paper, the legal environment has improved tremendously since independence. Investment laws are drafted by professionals, there is a right of appeal from first-instance courts, as well as a right of judicial review of administrative action. However, the drawbacks of the country’s political system make their mark on the legal system as well. For example:

• The judiciary is not independent from the executive. This means that there is potential for discrimination on grounds of nationalism or insufficient personal contacts. In these circumstances, a level playing field cannot be assured.

• Some very basic legal requirements for an investor-friendly environment are not met. This applies especially, though not only, to currency convertibility regulations.

• Some rules are satisfactory in theory, but their implementation is insufficient, as in the cases of privatisation or convertibility.

• Some requirements are simply too tight to make the environment viable for smaller investors, such as the minimum charter fund for businesses with foreign participation (US$150,000).

The old Soviet accounting system was in effect in the country until 1993. After tentative changes, the 1996 Law on Accounting established the basic principles that are now in place. The accruals method is used and accounting records should be kept on the double-entry principle. The accounting period is the calendar year. All businesses, regardless of the type of company, must make audited financial statements every year, following a format provided by the Ministry of Finance. This must be filed, with a tax declaration, by the 15 February (15 March for businesses more than 10% foreign), following the end of the taxation year. Entities with foreign ownership generally pay corporate-profits tax monthly in advance, based on an estimate or yearly taxable profits.

Tax reforms were introduced in 1991, and there have been changes since then, including a new tax code effective from January 1998. However, attempts to follow international practice have met with mixed success. Indeed, many of the most important joint ventures end up negotiating their own personalised tax regime with the government.

Resident taxpayers are subject to Uzbek taxation on world-wide income, whilst non-residents are subject to Uzbek taxation on Uzbek-source income. Companies are defined as resident if they were registered in the country or if they are controlled by a legal entity in the country.

There were a number of tax breaks and holidays before the new tax code. It seems that the latter will reduce their importance. The breaks provided for by the code apply to: newly formed businesses, export-oriented businesses and certain businesses with foreign investment (see below).

Penalties for undeclared income or arrears are strict. There is a daily interest charge of 0.15% of unpaid taxes. In addition, this is supplemented by the following:

• Undeclared income: 100% of concealed profits plus 100% fine as a minimum.

• Declaration of errors: up to 10% of the resulting tax liability, if the errors are disclosed voluntarily.

• Failing to file a declaration or preparing it improperly: up to 1% penalty per day of delay, within a 10% penalty ceiling.