Kazakstan Is Drowning In Contraband

Smuggling thwarts investors--and exacerbates a fiscal crisis

In Almaty's noisy wholesale bazaar, Erkin Takisaev patiently stacks cartons of Camel cigarettes into a pyramid. Despite the Western brand, black lettering on each carton lets customers know it's "Made in Kazakstan." Only there aren't any buyers for these cigarettes. Instead, they ask for the U.S.-made Camels that Takisaev gets twice a week from Uzbekistani smugglers and hides in a dirty sack. At $8.50 a carton, they cost more than locally produced cigarettes, but smokers prefer the taste.

Takisaev likes the profits. The Kazak-made cigarettes are taxed at up to 75%. Retailers stock them just to appease the police who look for contraband. The smuggled smokes, brought in tax-free, give wholesalers a margin of around 300%. "I can buy contraband cheap and make more money," says Takisaev.

TAX BITE. Vendors like Takisaev nettle Philip Morris Cos. and R.J. Reynolds Tobacco International, which together have invested more than $400 million to build production facilities in Kazakstan. Their heavily taxed, locally made brands can't compete with the billions of contraband cigarettes that flow into Kazakstan from Turkey via Uzbekistan. With their profits and market shares falling, both companies have shut down production intermittently and threatened to halt new investment. And their experience is likely to make other foreign investors think twice before putting money into Kazakstan. "If the government does not care for old investors, new multinationals are not going to come in," says Mark Duerst, head of Almaty Tobacco Co., a subsidiary of Philip Morris.

Kazakstan can ill afford to alienate two of its biggest investors. The government, facing a fiscal crisis, needs to attract multinational money to replenish its nearly empty coffers. And the economy, which grew only 0.5% in 1996, needs all the stimulus it can get. Unemployment in some parts of the country is as high as 30%, and inflation is expected to hit 17% this year.

A government crackdown on corrupt customs officials has done little to stem the flood of contraband. Duties collected on legal imports are down, and bribery remains rampant. Most customs agents earn just $50 a month. In 1996, the customs department received only half of the $26 million budgeted for its operations. That's not much, given Kazakstan's 11,000-kilometer border. Without bribes, customs officials would be hard-pressed to make ends meet.

The smuggling problem is causing political headaches as well as fiscal ones. Half of the cigarettes flooding Kazakstan's bazaars are duty-free imports by "charities" or other favored organizations that get tax breaks. As in Russia, criminals often take charge of such charities, using their tax exemptions to buy goods and resell them at huge margins. In Kazakstan, the U.S. tobacco companies estimate, these organizations are responsible for $60 million a year in uncollected cigarette taxes.

HOT TOOTHPASTE. Smuggling hurts makers of other consumer products, too. Consumer-goods multinationals don't have factories or large investments in Kazakstan. But Procter & Gamble Co. executives grumble about lax enforcement at the Kazak-Uzbek border that allows smuggled Dove soap and Crest toothpaste to undercut P&G'S legal imports.

President Nursultan Nazarbaev could halve smuggling by revoking the charities' tax breaks. But he is reluctant to do so. Most of the so-called charitable concerns and tax-exempt joint ventures enjoy considerable political patronage, and ending exemptions would displease many a bureaucrat. But Nazarbaev cannot hold off for long. Foreign donors are waking up to the problem. On June 20, the International Monetary Fund, which last year committed $446 million in a three-year aid package, threatened to suspend the loan if the government doesn't step up tax collections.

The multinationals have also turned up the heat in the past few months. U.S. companies are getting support from other foreign embassies who hear complaints from their own exporters. Consumer-goods makers have even promised to donate resources to customs if smuggling is stopped.

In Russia, President Boris N. Yeltsin recently revoked the tax privileges of charitable and sports organizations, which were among the biggest importers of duty-free alcohol and tobacco. Nazarbaev may soon follow suit. Until he does, foreign companies' investments will languish--and vendors like Takisaev will continue to thrive.

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