House of Commons - Foreign Affairs

Select Committee on Foreign Affairs Sixth Report

ECONOMIC PROSPECTS AND BRITISH COMMERCIAL INTERESTS

74. The United Kingdom's primary interests in the region are economic and commercial. The FCO includes in its objectives for the region:

"— to encourage progress towards.....economic reform;

— to help secure substantial business for British companies."[153]

We examine in this section the economic potential of the region, the United Kingdom's involvement in supporting economic reform through international institutions, the commercial potential of the area, the obstacles to doing business, assistance provided by the British government to business, corruption, the potential of the hydrocarbon sector, and then the issue of pipeline politics and Iran.

75. All of the countries of the region suffered severe economic dislocation as a result of the break up of the Soviet Union, as trade routes were disrupted, skilled personnel departed, hyperinflation took off, and state institutions lost their legitimacy with the loss of the Communist party's monopoly on power. Dr John Anderson of St Andrews University informed us that reform in all of the countries of the region has been characterised by "the growth in levels of corruption and the perception that a small minority is doing well out of the changes: the inability of these states to collect all the revenue owed to them; the closing or 'downsizing' of such industries as do exist leading to unemployment and social deprivation."[154]

76. GDP is lower than in Soviet times in all countries of the region, with the four countries most affected by war having suffered the most severe declines: in Georgia in1998 GDP was 32 per cent of the 1989 level; in Armenia, 38 per cent; and in Azerbaijan and Tajikistan 40 per cent. The government of Turkmenistan has presided over almost as steep a decline without having experienced a war (GDP is 44 per cent of the 1989 level).[155] The collapse of the Russian economy has contributed to this bleak picture, with the Russian devaluation and default of August 1998 causing further problems, disrupting trade and provoking declines in the values of currencies. The European Commission concluded that Armenia, Georgia, the Kyrgyz Republic and Tajikistan were the countries of the region worst affected by the crisis.[156]

77. As a result of these deprivations, the economy of the region is relatively small, representing in total less than 5 per cent of the United Kingdom's GDP, or around half that of Portugal.[157] Kazakhstan has the largest economy, representing around 43 per cent of the eight countries' combined GDP[158]; it also has the highest GDP per capita. The total population of the eight countries of the area is 65 million (Uzbekistan is the largest, with 23.6 million), but the size of the market is limited by the poverty of its inhabitants. One study estimates that expenditure on food has risen to 70 per cent of household income, and malnutrition is increasing.[159] In June the Food and Agriculture Organisation of the UN included Armenia, Azerbaijan, Georgia and Tajikistan among the 37 countries in the world suffering from "shortfalls in food supplies in current marketing year requiring exceptional and/or emergency assistance."[160] However, while the market for consumer goods and services is not large, the rich hydrocarbon and mineral reserves of the region represent both an opportunity to increase trade in the future, and also to improve the economic security of the United Kingdom by diversifying the supply of vital raw materials.

78. The opportunities available for British business depend to a great extent upon the economic policies adopted by the governments concerned. Nowhere in the region has the process of transition from the state controlled systems of the Soviet era to a market economy gone as far as in the countries of Central Europe, perhaps reflecting the fact that in most of Central Asia and the South Caucasus, Soviet era regimes are still largely in place. Nonetheless, there have been a wide range of approaches to economic policy in the region. Dr Herzig told us:

161

According to Uzbek government statistics, Uzbekistan's economy has declined by less than any other in the region (GDP is 88 per cent of its 1989 level).[162] As a consequence of its "third way" Uzbekistan's economy remains largely in state hands, with only 45 per cent of GDP generated by the private sector (although this is still more than Turkmenistan, where the equivalent figure is 25 per cent). The Kyrgyz Republic, Georgia and Armenia have all privatised their economies to a greater degree, with 60 per cent of GDP generated by the private sector.[163] Overall, the EBRD[164] judges that Georgia, Kazakhstan and the Kyrgyz Republic have made the most progress in introducing market economies, while Tajikistan and Turkmenistan have made the least.[165] Tajikistan's civil war has reduced the capacity of the state to introduce reform, while Turkmenistan has maintained the Soviet system as a matter of policy.

Relations with the international financial institutions and the EU: economic conditionality

79. The direction of economic policy in each of the countries has been heavily influenced by their relationships with the international financial institutions: by the extent to which they take advice, and the extent to which they receive aid. We heard from Mr Hannan that:

"... The Kyrgyz Republic, one of the poorest of these states,...is absolutely dependent upon the IMF—and, to some extent, the EU.....[Aid dependency] is much less striking in the case of some of the other states..."[

166

We discuss above the EU's aid programmes to the region.[167] There are also large bilateral programmes in some of the countries: for example, the US Embassy in Yerevan told us that the US provides $143 million per year to Armenia. The Know How Fund (KHF) has small programmes in all of the countries of the region, ranging from £1.5 million in Kazakhstan to £0.2 million in Turkmenistan. The focus of aid to Tajikistan has been humanitarian rather than technical, with several million pounds contributed through the EU, the UN and the Aga Khan Foundation.[168]

80. Asked whether the aid flows to the region had been well spent, Mr Hannan told us:

169

The FCO informed us that "DFID are supporting international efforts to assist with Kazakhstan's two major environmental disasters: the shrinkage of the Aral Sea due to environmental mismanagement in the Soviet era and health problems in and around the Semipalatinsk nuclear test range."[170] We discuss the water crisis facing the region above.[171]

81. Apart from the direct benefit of aid, the promise of assistance can also be used to influence policy-making in recipient countries. We discuss below the human rights commitments within the Agreement Establishing the EBRD.[172] The Agreement also requires the Bank to support development only in countries "committed to and applying the principles of ....market economics."[173] There are elements of economic conditionality in the programmes of other international financial institutions, but no conditionality based on political criteria (at least explicitly). With reference to Uzbekistan, the World Bank has agreed with the Uzbek Government to commit only modest financial resources, given the Government's present limited reforms: however, if the Government were to implement broad-based policy reforms, the financial support would increase significantly.[174] In contrast, the World Bank's Country Assistance Strategy for Tajikistan states that the trend toward improvement in the country merits its expanded support and adds that without its support the trend cannot remain positive.[175]

82. Similarly, conditionality in the IMF's programmes focusses on economic and financial issues.[176] All of the countries of the region bar Turkmenistan and Uzbekistan have agreements with the IMF, which include commitments to a range of liberalisation and stabilisation measures: for example, Armenia's letter of intent of 18 December 1998 includes a commitment to a budget deficit target.[177] We heard in Turkmenistan that the IMF had offered the Turkmen Government a first-phase assistance package of £35 million. However, the two parties had not been able to agree on the conditions to be attached to this package. Turkmenistan has pleaded the effect of external factors on its economy, but the IMF believes that improvements can be made in the areas of transparency and sound fiscal management. No agreement seems likely in the short term. While there is some criticism in the region of the effect on ordinary people of IMF austerity programmes, a matter raised with us in Armenia and Georgia, the two countries without IMF programmes are not performing notably better than those countries with programmes.

83. For the EBRD, there appears to be no correlation between the amount of money allocated to a particular country and the extent to which it applies principles of market economics. For example, in 1998, greater funding was allocated to Uzbekistan than to Kazakhstan or Tajikistan, and almost as much as to the Kyrgyz Republic, the most liberal of the Central Asian economies.[178] Turkmenistan also receives considerable funding (see below, Table 7), despite the fact that the EBRD classifies the country as having a trade and foreign exchange system characterised by "widespread import and/or export controls or very limited legitimate access to foreign exchange."[179] In fact, the EBRD states that "as part of its mandate, the EBRD is committed to operating in all 26 of its countries of operations,"[180] apparently ruling out the use of any conditionality. This requirement to operate in all 26 countries is an interpretation of the Agreement Establishing the EBRD, but it is not clearly stated in that Agreement—certainly not as clearly as the commitment to operating only in countries which apply the principles of market economics.[181]

84. This approach presents two problems. Firstly, EBRD projects may be wasting money by investing in countries where the economic system is highly distorted (for example, the renovation of the port at Turkmenbashi in Turkmenistan will not achieve its potential while the Turkmen currency is artificially fixed at a rate which will prevent trade developing.). Secondly, efforts by the international community to influence the policies of governments in the region will be less effective, as the EBRD appears to undertake projects regardless of the economic (or indeed political situation.[182] There are some indications that the EBRD may be shifting its stance. The Chief Economist of the EBRD, Nicholas Stern, was quoted as saying that as the region's largest investor, the EBRD had the clout to "be more vocal."[183] But this is not sufficient. We believe that conditionality is most effective when donors coordinate policies. We recommend that the Government should use its position within the EBRD to ensure that the EBRD does not spend money in countries which do not have programmes agreed with the IMF and World Bank.

Commercial potential

85. Until the Russian crisis of August 1998, trade between the United Kingdom and the countries of the region was growing fast, albeit from a small base. As Table 3 demonstrates, our exports are around a third of those of France and Germany, although higher than those of Italy. These trade figures need to be treated with some caution: for example, Armenian government figures show a much higher level of trade, routed through Moscow and Rotterdam, than UK government figures.[184] We were informed by British Invisibles that, as far as the service industries of its members were concerned, "unlike 'visible' exports, there are no comprehensive statistics, official or otherwise, to record [the growth in trade]."[185]

TABLE 3

Exports from selected European countries to Central Asia

and the South Caucasus (1997) (£000s)

	FRANCE	NETHERLANDS	GERMANY	ITALY	UK
ARMENIA	16,659	6,740	18,468	10,403	7,212
AZERBAIJAN	13,989	12,361	43,344	14,015	55,653
GEORGIA	17,082	9,741	40,292	37,154	11,788
KAZAKHSTAN	485,247	35,509	242,665	37,040	52,746
KYRGYZ REPUBLIC	4,638	4,339	20,032	5,859	2,946
TAJIKISTAN	3,557	2,761	6,064	2,087	1,441
TURKMENISTAN	22,449	2,727	42,809	11,379	9,865
UZBEKISTAN	38,666	27,883	267,356	30,054	91,578
TOTAL	602,286	102,061	681,030	147,991	233,229

Source: Eurostat

86. The most important industries engaged in trade with the United Kingdom in the region are extractive, with the four hydrocarbon rich countries (Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan: see paragraphs 96 and 97 below) having the brightest prospects in this area, but with metals also important (Uzbekistan is the seventh largest gold exporter in the world, and Armenia, Kazakhstan, the Kyrgyz Republic and Tajikistan also have reserves).[186] Agriculture is important across the region, with significant local variations (in the Kyrgyz Republic 43 per cent of GDP was generated by agriculture, while the equivalent figure in Kazakhstan was only 11 per cent).[187] Much of this is subsistence, but Uzbekistan, for example, is the third largest exporter of cotton in the world.[188] We heard from Mr Hannan:

189

British business in the area is by no means restricted to extractive industries, or to those countries which have resources to extract: for example, we found that one major British company, HSBC, had established an operation in Armenia which had proved more successful than its outlet in Azerbaijan, despite the international business attracted to Baku by its oil wealth. The UK is the largest foreign investor in Armenia.[190]

Obstacles to business

87. Commercial relationships are in many respects the most dynamic feature of the United Kingdom's bilateral relationships. Throughout our visits to the region we were told of the excellent investment record of large enterprises based in the United Kingdom, and were invited to encourage SMEs (small and medium enterprises) to invest. The FCO informed us that: "Trade promotion is a major function of our posts in the region."[191] However, as one member of British Invisibles put it: "the reason....British firms were not as active as [the] potential would lead one to expect...was a combination of sheer difficulty of working in the region, low fees, delays on the part of the Governments there in making up their minds on what was required e.g. Stock Exchange, privatisations and pension legislation."[192]

88. Bureaucratic structures, methods and attitudes persist from the Soviet era. Commercial law is often unwieldy, unworkable or poorly-drafted to the extent that foreign companies find difficulties in establishing the state of the law and ensuring compliance. Laws are published and passed with little or no consultation with business, and are enforced capriciously. We were informed by Rio Tinto plc that ventures in Kazakhstan and Uzbekistan had failed, and that while both countries had "world-class mineral resources" neither had "an acceptable investment climate."[193] We heard during our visit to Kazakhstan that the problem was often not that appropriate legislation did not exist, but that it was not implemented effectively. GEC informed us that "it is very hard to obtain adequate hard currency exchange authority in Uzbekistan, yet it is fairly common knowledge that the privileged in the country have little problem in so doing."[194] In terms of dealing with the governments of the region, one problem was the constant changes in personnel at all levels.

89. We also heard that declining domestic tax bases lead the revenue authorities at national and local levels to seek to extract as much income as possible from foreign enterprises. It is in markets such as these that trade services provided by the Government can be most important to businesses. Companies invest where they see an attractive risk adjusted rate of return on their capital: if governments of the region want companies to invest, they need to reduce the risks of making investments by reducing the unpredictability of policy making and policy implementation. One way in which the British Government can help governments of the region to establish a more stable and law-governed commercial environment is through the Know How Fund (KHF): for example, a recent KHF project in Azerbaijan has helped to produce a draft commercial code.

90. In both Azerbaijan and Turkmenistan we were told of a lack of indigenous skills in technology, administration, and business and financial management. The sound education systems inherited from the Soviet era are deteriorating. Many problems have been created for potential investors by lack of transparency and openness in financial dealings. We were particularly struck by the difficulties in Turkmenistan. It suffers from a decaying infrastructure, including the electricity system. Visa restrictions can also act as a deterrent: visas issued to foreign visitors are usually valid only for Ashgabat and permission to travel elsewhere in the country can take two or three weeks to obtain. A requirement for visas for travel from Turkmenistan to other CIS countries has also recently been introduced.

British Government assistance to business

91. The experience of HMSO and its contract to supply stationery products to a state-run Uzbek concern, which resulted in a loss of £3.2 million to the public purse, is a case-study in the difficulties inherent in doing business in the region.[195] Unlike HMSO in 1995, many businesses of course have a great deal of experience of dealing with the problems they face in developing countries. Ms Quin told us that if firms "....are big, confident actors in the international economy they know how to operate without needing necessarily to use the services of a local post."[196] On the other hand, representatives of large companies informed us of the useful role played by missions in the area, often doing the traditional job of diplomats of providing political and economic analysis of the countries to which they are accredited. Mr Chapman, Executive Director of BG plc, told us that his company used the FCO "a great deal for its views on economic and political developments, and that was particularly of use in recent times when the Russian crisis was upon us."[197]

92. Mr Barr, of BP Amoco, confirmed this view, telling us that "the diplomatic skills of the [Foreign] Office and the embassies [are] highly valued by us."[198] A member of British Invisibles spoke of the "continuing overlap between the 'political' and 'commercial' aspects of what an Embassy is supposed to do."[199] Another example, which has had implications for billions of pounds of investment by British companies, was given to us by the former President of the AIOC[200] Consortium, Mr Adams:

201

This illustrates that the FCO's role is not limited to that played by its missions within the region. Because the politics and economics of the region are so affected by outside powers—Russia, Turkey, Iran, China, the USA—the United Kingdom's influence in Moscow, Ankara, Tehran, Beijing and Washington is also of considerable importance in promoting British interests in the South Caucasus and Central Asian area.

93. In other cases, businesses found specific commercial intelligence of most importance. This might be provided by posts in the region, or from London, by British Trade International (jointly staffed by the FCO and the Department of Trade and Industry). An example was provided to us by Mr Adams:

202

On a smaller scale, GEC found "Market Reports to be very well researched and very good value for money. The £70 fee when set against the £3000 a visit may cost is a significant saving particularly when the report indicates that, for whatever reason, there is unlikely to be any business."[203] Our overall impression is that small and medium sized enterprises have most to gain from posts' services. Mr Peters, Deputy Director of the British Consultants Bureau, told us that:

204

Mr Peters also gave us an example of the way in which the Embassy in Georgia had made an introduction during a trade mission which resulted in a Tacis contract to work with the Central Bank of Georgia.[205]

Corruption

94. We heard from Mr Meredith Jones that corruption in the region can be divided into two categories: the first concerns officials abusing their position to extract payments, for example, for crossing a border. The second, which he called "briefcase corruption" is where "the West does not have a perfect record. People arrive with a briefcase full of notes and it is put down in front of someone of considerable importance and that is to purchase a contract. That does happen, it happens in most businesses."[206] He went on to explain that he himself was involved in a case, subject to arbitration, where his company had resisted paying "monies outside the contract", which had "cost us very dear indeed."[207] A member of British Invisibles also attributed the low levels of involvement by the City in the region in part to corruption.[208] A number of people we met during our visits to the region also spoke of the problems of corruption which they had encountered, which in some countries appeared to be almost endemic.

95. The experience of corruption in the area appears to vary according to the size of the company involved. Mr Chapman told us:

209

We heard from Mr Adams that:

210

When asked whether it would be helpful for the EU and the G8 to adopt similar legislation, he said:

"It would benefit industry at large, it would benefit individuals on the ground and protect companies in a way which is perhaps not appreciated externally."[211]

The OECD Anti-Bribery Convention, which "obliges signatories to adopt national legislation that makes it a crime to bribe foreign public officials"[212] and is based upon the US Corrupt Practices Act, came into force in February 1999. The UK ratified the Convention on 14 December 1998, on the basis that existing legislation allowed the UK to meet the requirements of the Convention, although the Government is "considering the formulation of a new public statute on corruption. It is hoped that a public discussion document on proposals for new legislation on corruption will be published before the UK parliamentary summer recess."[213] We have been told by the Home Office that the Government is now planning to publish a discussion document on corruption and the misuse of public office later this year. All members of the OECD have signed the Convention, and 15 have ratified it.[214] The OECD of course includes all members of the EU, and all members of the G8, bar Russia, which has "expressed interest" in the Convention. We welcome the steps that have been taken within the OECD to mirror the US Corrupt Practices Act, and recommend that the Government should continue to take all possible steps to end corrupt practices in business, in order to create a level playing field internationally.

Hydrocarbons

96. Initial Western interest in the region after the collapse of the Soviet Union was fuelled by reports of massive and readily exploitable oil and gas reserves. As Ms Quin has said, "figures remain very speculative,"[215] but BP estimates that the region contains around 16 billion barrels of oil reserves, and 262 trillion cubic feet of gas,[216] while the US Department of Energy estimates that it has almost 29 billion barrels of oil and 266-327 trillion cubic feet of gas.[217] We heard from Mr Adams that:

218

British companies have been in the vanguard of oil and gas exploration and extraction, mainly as partners in multinational consortia, and have established significant positions in Azerbaijan, Turkmenistan, and Kazakhstan. Ms Quin has said that: "the Kazakhstan Caspishelf Consortium of nine foreign companies, including BP, British Gas International [now BG plc] and Shell successfully completed in the North Caspian what I understand to be the most expensive seismic project to date....".[219] This investment has not been assisted—but nor has it been prevented—by a dispute among the littoral states of the Caspian over the status of the Caspian Sea. The British Government's view is that while "the progress made [in 1998] is welcome, including the agreement signed between the Governments of Kazakhstan and Russia," nonetheless "the status issue is one for the littoral states themselves to resolve."[220]

97. Low oil prices have a negative effect on the oil producing countries of the region (though they are welcome in a country like Armenia). We heard in Azerbaijan, for example, that the country might have revenues of up to $80 million over the next 30 years if oil sold at $25 a barrel. If it sold at $10, Azerbaijan would receive virtually nothing. Recent low oil prices certainly have led some companies to scale down their operations, and two wells recently drilled in the Karabakh offshore prospect, in Azerbaijan's waters, produced only gas, while the field had been believed to contain oil reserves of at least 70 million tons. Without local demand or a means of transporting the gas, it has to be flared off, wasting a potentially valuable resource.

Iran and pipeline policy

98. As one oil company representative put it:

"There are undoubtably large amounts of barrels of oil and cubic feet of gas in the region. The constraining factor...is the pipeline routes and the ability to export...the key issue over the next decade is going to be generating efficient oil and gas evacuation routes and having Foreign Office help in doing that."[

221

The routes of these pipelines clearly have geopolitical as well as economic implications. Most of the current export routes for the hydrocarbons of the Caspian basin use the old Soviet pipeline system, which passes through Russian territory. This is inefficient, costly and subject to disruption. The US has lobbied hard for American companies to build a pipeline from Baku in Azerbaijan, through Georgia and then to Erzerum in Turkey and on to Ceyhan on the Mediterranean coast. One commentator has said that this pipeline represents "the basic building block for a more ambitious 'east-west energy corridor' that Washington would like to establish as part of its diplomatic effort to wean the former Soviet republics of the Caspian Sea region off their dependence on Russia, while at the same time blocking recent commercial momentum to develop export routes from the Caspian via Iran."[222] A US Government representative has said that an "east-west Eurasian transport corridor.....is key to preventing Iran from undermining the kind of Central Asia we are seeking."[223]

99. In contrast to US policy, Ms Quin has said that "the British Government believes strongly in the development of multiple pipelines to export Caspian oil and gas. We also believe that the decisions on pipeline routes are largely for the companies concerned."[224] British companies have therefore received the support of the Government when they have sought the most economical export routes, regardless of geopolitical concerns. For example, a consortium led by BG plc and Agip signed an agreement with the government of Kazakhstan in June to build a pipeline connecting the Karachaganak field to another pipeline which will use the Russian port of Novorossisk.[225] The British government has also not opposed the use of Iranian territory for the construction of pipelines.

100. Ms Quin told us that:

226

With regard to US pipeline policy, the FCO informed us that:

227

This Statement does not appear to have had a dramatic impact on US policy, which continues to be "clearly directed to excluding Iran from any significant participation in the economic and energy development of the region."[228]

101. Business people operating in the area generally welcomed the British Government's attitude towards Iran. Mr Chapman, Executive Director of BG plc, told us that "we are fortunate in Britain in that we are not required to toe a political line on an issue such as Iran or Baku Ceyhan, and I would like to compliment the government on this. It is extremely helpful."[229] He went on to say:

230

Mr Adams, of Monument Oil and Gas, reinforced this point:

231

Mr Chapman told us that one area where United Kingdom policy as part of EU policy was helpful was:

232

Monument told us that the advantage they experienced from using the Iranian pipeline system—which US competitors could not do—was $1.50 per barrel.[233] The FCO informed us that during the United Kingdom's Presidency of the EU, an undertaking was secured "to consider formal waivers from the provisions of the Iran-Libya Sanctions Act (ILSA) for EU companies doing business in the Iranian oil sector. It has not yet been tested whether such treatment will apply to pipeline projects specifically. But the EU has clearly stated that it is axiomatic that investment in pipelines in Iran should be carried out without impediment."[234] We support the Government's policy of multiple pipelines. We recommend that the Government should continue to use its best efforts to discourage the US Government from promoting particular pipeline routes, for purely political reasons, to the detriment of other more economic routes.

153 Evidence p. 79. Back

154 Appendix 5, Evidence p. 122. Back

155 EBRD Transition Report, 1998. Back

156 Communication from the European Commission to the European Parliament and the European Council, COM (1999) 8, 20 January 1999, "The Russian Crisis and its impact on the New Independent States and Mongolia." Back

157 The combined GDP of the eight countries of the region in 1997 was around £32bn (EBRD figures), while the GDP of Portugal was around £60bn, and the United Kingdom around £700bn (The Economist Pocket World in Figures, 1999). Back

158 EBRD figures for 1997. Back

159 Martha Brill Olcott, "The Caspian's False Promise," Foreign Policy, Summer 1998, p. 101. Back

160 FAO/GIEW Foodcrops and Shortages Number 3, June 1999. Available on FAO web site: www.fao.org. Back

161 Q26. Back

162 EBRD Transition Report, 1998, Table 3.1. Back

163 EBRD Transition Report 1988, Table 2.1. Back

164 The European Bank for Reconstruction and Development was established in 1991. It describes its purpose as to: "foster the transition towards open market-oriented economies and to promote private and entrepreneurial initiative in the countries of central and eastern Europe and the Commonwealth of Independent States (CIS) committed to and applying the principles of multiparty democracy, pluralism and market economics." and "to help its 26 countries of operation to implement structural and sectoral economic reforms, promoting competition, privatisation and entrepreneurship, taking into account the particular needs of countries at different stages of transition. Through its investments it promotes private sector activity, the strengthening of financial institutions and legal systems, and the development of the infrastructure needed to support the private sector." Extract from the EBRD web site: www.ebrd.org. Back