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Free Economic Zone Experiment in Kyrgyzstan Fails

In Kyrgyzstan, only one of five free economic zones is operating. However, its contribution to the national economy is minimum.

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Special zones first appeared in Kyrgyzstan in 1991 to 2011. A successful global experience has been taken as the model: special economic zone in Jebel Ali that has improved the economy of Dubai and FEZ in China that turned poorest coastal areas of the country into booming areas.

Free economic zones (FEZ) operate in special tax regime. Preferences are set depending on their objectives and tasks. In Kyrgyzstan, they were created to improve the competitive ability of the country in global markets. FEZ entities were supposed to work for export dominantly, so their operations were exempt from all kinds of taxes under applicable laws.

Article 8 of law “On free economic zones in the Kyrgyz Republic” dated December 16, 1992 read clearly that:

Export of goods produced in the free economic zone shall be exempt from quotas, except for export to the customs territory of the Kyrgyz Republic, which volume shall not exceed 30 per cent of total volume of goods produced in FEZ, within a year and from licensing.

Thus, one of the key conditions for the operation of an entity in a special zone was that 70 per cent of goods produced should be exported to third countries.

However, as the law “On FEZ” was amended at least nine times, the paragraph about precise proportions of export/import of goods was removed. According to director of Central Eurasia Transboundary Research Network Denis Berdakov, it was a great mistake of the government.

“The 30 to 70 per cent rate was correct however provided that industrial companies would enter the [FEZ]. However, such companies were not interested, so everyone was allowed to enter the FEZ. This rate was unfavourable both to them and to Kyrgyzstan. So, it has been a wrong idea to let non-export-oriented company in. In the end, the rate was cancelled, and it compromised the idea of FEZ,” Berdakov said.

If the company does not export its goods to third countries, but sells them in the domestic market of Kyrgyzstan, it loses all tax preferences. Its operations shall be taxable without any preferences. So, its presence in special zones becomes useless.

Special zones and fees

The fee for operation in FEZ is fixed at the rate of 0.5-2 per cent of proceeds of sales of goods, works and services.

Conditions of presence in different free economic zones of Kyrgyzstan vary. For example, FEZ Bishkek applies a rate of 2 per cent of proceeds of sales of goods, works and services in the territory of the country and 1 per cent of proceeds of sales of goods, works and services beyond the republic for the right to operate.

‘Karakol’, ‘Leilek’, ‘Maimak’ and ‘Naryn’ FEZs apply 1 per cent fee from the proceeds of sales of goods, works and services both within and beyond the republic.

The largest zone among five free economic zones in Kyrgyzstan is ‘Bishkek’ FEZ by the number of its active participants. According to some experts, it is the only operating zone and contains the main amount of total goods produced.

“It produces 99 per cent of goods in money terms. Such free economic zones as ‘Leilek’ have completely failed due to no infrastructure,” Berdakov said.

In fact, speaking of free zones of Kyrgyzstan, everyone means ‘Bishkek’ FEZ. It draws all the attention today.

Investment and jobs

Investors of 17 countries operate in ‘Bishkek’ FEZ. Bishkek FEZ drew investments for 17 million dollars in nine months of 2019.

At the national level, ‘Bishkek’ FEZ attracted 3.13 per cent of all investments in the country. According to the National Statistical Committee, in January to June 2019, investments to Kyrgyzstan amounted to 393.73 million dollars.

Nevertheless, investments are on the rise, which cannot be said about the decreased number of entities in five years. Today only 310 companies operate instead of 357, which operated in 2014.

The steadily growing interest of the business to the Bishkek FEZ was obvious in 2014 to 2017, and the average annual increase in the number of free zone entities is 14 companies.

However, the number of operating entities is not always directly related to the number of jobs. The peak of the number of workers at the Bishkek FEZ was in 2016, when 377 companies were operating there.  And in 2018, only 2.9 thousand jobs were created in 399 entities.

If we take all Kyrgyzstan, FEZ has contributed insignificantly to the number of newly created jobs – a little more than 0.1 per cent of the total working population (according to the National Statistical Committee, 2.54 million workers were in 2018).

The majority of companies operating in FEZ simultaneously was in 2017 – 399 entities. A sharp decrease in the number of free zone entities was in 2018, when 101 entities stopped their operations. According to Denis Berdakov, the reason was the introduction of new rules of operation in January 1, 2019.

“They are about the companies that violate the proportion of sale of their goods to foreign and domestic markets, which must leave free economic zones,” the expert said.

If we analyse the activities of FEZ entities, we can conclude that there are few hi tech enterprises.

If we compare the data by the amount of produced and exported goods, we can conclude that the majority of goods and services remain in the domestic market.

This is a failure

The idea that free economic zones will concentrate industrial entities, which will assembly, complete and sell something to neighbouring countries, has failed almost at the very beginning, Denis Berdakov said. In his opinion, the reason was weak infrastructure, which development was underfinanced.

Economist Iskender Sharsheev also thinks that FEZ is a failure. FEZ entities were supposed to supply raw materials at zero customs duty and sell them abroad. However, when Kyrgyzstan became the member of the Customs Union, the conflict of law arose.

“Raw materials are not so cheap to supply and sell anymore. Also, the Customs Code does not provide special conditions for FEZs. Today, free zone entities have the same expenditures as ordinary limited companies operating in Kyrgyzstan, the difference is just 1.5-2 per cent. Therefore, the existing FEZ structure can be deemed ineffective and unclear,” Sharsheev said.

The frequent amendments in rules and laws have played a significant role, as well. According to experts, this has decreased the value of FEZ itself.

Deputies have attempted to improve the situation. They suggest other amendments to the law. The document does not contain essential changes. In particular, the law is going to give an opportunity to companies that operate in FEZ to provide services. However, today 7.1 per cent of FEZ entities are companies that provide services.

This article was prepared as part of the Giving Voice, Driving Change – from the Borderland to the Steppes Project.

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