Hundreds of millions of dollars go missing every year in Central Asia, thanks to trade fraud. Exports are sent to strange destinations, and imports are not all they seem to be. The worst-affected countries are Kazakhstan and Uzbekistan, where both governments are responding through increased trade regulation. The unpleasant reality is that strange foreign trade flows are as much a result of official policy as outright mischief, with more state control likely to make matters worse. [For backrgound see EurasiaNet's Business & Economics Archive.]

Kazakhstan's problem is on the export side. According to the government, some of Kazakhstan's oil producers sell oil at discount prices to shell companies in Caribbean tax havens. These shell companies, having obtained Kazakh oil on the cheap, then sell it to the true end customers at far higher prices, a practice known as "transfer pricing." According to official figures, some crude was exported in the second quarter of 1999 for just $7.90 per barrel, while the price of Brent crude oil, a global price benchmark, was $15.40 per barrel. The true Kazakh oil export price to the end consumer was probably around $12.00 per barrel lower than Brent because of transport costs and blending, meaning that there was $4.10 per barrel difference for undeclared exports. The reason for this transfer pricing was that Kazakhstan imposed a 50 percent surrender requirement on all hard currency export earnings as of April 5, 1999. Exporters therefore had an incentive to under-declare the true value of their sales, thus avoiding selling hard currency to the government.

The surrender requirement was scrapped in November 1999, but oil exports to the Caribbean have risen steadily. In the first half of 2000 an incredible $1.1 billion of Kazakhstan's total $1.6 billion in oil exports went to the Caribbean. Grigori Marchenko, head of the National Bank of Kazakhstan, claims that 70 percent of all capital flight from Kazakhstan is a direct result of transfer pricing. The government threatened to impose export duties and even export quotas, but is instead bringing in regulations to completely ban transfer pricing. The Kazakh government is off target. While it is true that 250,000 barrels per day - out of total oil exports of 422,000 barrels per day in the first half of 2000 - went to the Caribbean, the export price achieved was quite high. Bermuda-registered companies bought 143,000 barrels per day of oil at $23.97 per barrel, while British Virgin Islands-registered firms took 107,000 barrels per day at $22.57 per barrel, according to official figures supplied by Golden Eagle Services, a local information company. By contrast, the average Kazakh oil export price in the first half of 2000 was $20.80 per barrel. The state-owned oil company, Kazakhoil, earns the least for its oil exports and sells to former Soviet markets. Kazakhoil is, however, politically well connected and so receives little, if any, government criticism.

Uzbekistan's trade problems are larger, as they involve both exports and imports. Uzbek trade controls are very strict on paper, but they are undermined by a system of low domestic prices and multiple exchange rates. In the case of the cotton industry, which is riddled with dishonesty and double-dealing, the issues arise at both the local and governmental levels. Every year a substantial part of the cotton crop is stolen and smuggled abroad. Farmers lie to provincial officials, who in turn lie to the central government in Tashkent. The reason is simple: in 2000, the government paid farmers just 9.9 cents (at the free market bazaar exchange rate) for their cotton, but exported that cotton for around 50 cents per pound. Unsurprisingly, declared cotton production in Uzbekistan is falling steadily. Whereas from 1991 to 1995 the average annual crop was 4,176.2 million tonnes, in 1996 to 2000 the annual average was 18.1 percent lower at 3,420.4 million tonnes. Some of this fall is due to the government's failure to reform the agriculture sector. The rest - in particular in Dzhizak and Syrdarya provinces, according to the IMF – can be attributed to light fingered farmers and officials withholding cotton and then selling it for their own benefit in Kazakhstan. Cotton fraud is something of a tradition in Uzbekistan. During the Soviet era, the Communist Party leader in Uzbekistan, Sharaf Rashidov, ripped off the Soviet government to the tune of billions of rubles (then worth something), by systematically inflating the size of the cotton crop. President Islam Karimov rehabilitated the disgraced Rashidov, turning him into a national hero and sending the, perhaps, unintentional signal that fraud is acceptable.

In addition, Uzbek officials are salting money abroad by manipulating import prices. According to official figures, capital goods made up 40 percent of all imports in the first half of 2000. This is consistent with President Islam Karimov's policy of giving capital goods imports privileged access to foreign exchange reserves, so that they can be used to build up domestic industries. Local managers take advantage of this by arranging for the foreign supplier to inflate the price of the capital goods. The difference between the true price and the price Uzbekistan pays is then split between the foreign supplier and the Uzbek importer, with the proceeds kept overseas.

Stricter regulations will drive honest investors away while encouraging the dishonest to be more skilfully devious. Kazakhstan cannot afford to alienate foreign investors— foreign joint ventures accounted for 56.4 percent of exports in the first half of 2000. Uzbekistan, which desperately needs foreign investment, must avoid enhancing its already poor reputation for bureaucracy and corruption. Both governments need to remember that sounder policies and a less corrupt business environment will attract more honest investors.