On February 1, the Kyrgyz Finance Police accused Centerra Gold Inc. of tax evasion. It also claims that former Prime Minister Nikolai Tanaev “exceeded his power,” providing Centerra with privileges at the expense of national interests. The Canadian mining company categorically rejects the allegations. Centerra officials worry about the unpredictability of the outcome of negotiations, which might linger for months. Be it because of corruption or yearning for better terms, the Kyrgyz government’s deeds might well undo its loud rhetoric about setting up a favorable investment climate in the light of grand privatizations ahead.

BACKGROUND: Since its onset in 1992, the Kumtor mining operation has been clouded with seemingly endless suspicions over the terms of the initial contract. Discussions and arguments about securing better terms and the possible nationalization of Kumtor, often called the “locomotive” of Kyrgyzstan’s economy, dominated the parliament ever since the first foreign company showed interest in it. Yet, the government repeatedly eschewed to reveal answers as to why the state budget reaped less benefits than the company did.

In 1994, former president Askar Akaev dissolved the parliament, in an attempt to cow into silence further trouble-breeding talks that had led to dismissal of Prime Minister Tursunbek Chyngyshev, a key actor during the negotiations with the gold company. Parliamentarians and observers criticized the absence of a tender, disregard for local experts’ evaluations, and “personal interests of top government officials” that led to a deal with Comeco, the giant Canadian uranium corporation.

Ten years later, another wave of scandals was triggered, as the government tried to change the general agreement in order to make it more favorable for the country. Opposition-oriented parliamentarians criticized the fact that the Canadian company had been freed from taxes for a decade, during which it exceeded the production limit by a factor of two developing surface gold reserves. Although the company produced more than 150 tons of gold by 2003, the government did not see a considerable inflow to the budget, partly owing to low gold prices and continued payment for money borrowed from various banks for the initial investment. However, former president Akaev refrained from reckoning with the parliament, and proceeded to further talks engaging a limited number of government officials.

Comeco welcomed the offer to revise the general agreement, since the tax-free period was coming to an end, and it would have to pay dividends to the Kyrgyz government in the order of 66 percent, explained opposition parliamentarians. In early 2004, Comeco and Kyrgyzaltyn, the state gold agency, joined into Centerra Gold Inc. The Kyrgyz side decreased its share from 66 percent to 30 percent, while Comeco, in exchange, agreed to pay taxes, share dividends from other developing gold mines in Mongolia and the U.S., and allow Kyrgyzaltyn to sell its share in stock markets. Notably, Centerra Gold Inc. became an “investor” in the Kumtor project, which made it eligible for special privileges according to the national Law on Investment. However, the deal was achieved without the required approval of the parliament, something that would become a thorn in future disputes. Later that year, the government sold about 15 percent of its share for US$90 million, as became known, to invest in social projects such as poverty reduction.

After the ouster of Askar Akaev following the mass protests in March 2005 and pushed on by high expectations, the new government led by Kurmanbek Bakiev promised to revisit the situation surrounding the gold mine, from which the former president and his entourage were thought to have illegally benefited. Additionally, on the financial side, as profits were counted on the basis of sales, Centerra Gold continually invested back into the project in 2005-2006, decreasing the revenues flowing into the state budget. Hence, the new government decided to revise the general agreement in order to better serve the national interest.

IMPLICATIONS: At present, many officials and parliamentarians appear surprised, as investigations began on the eve of the expected approval by the parliament of the new “peace” agreement between the Canadian corporation and the Kyrgyz government. It is believed that the new agreement, achieved by former Prime Minister Almazbek Atambaev in August 2007, was reached through exhaustive negotiations, and would restore a relative balance between the sides. It would increase the state’s share in Kumtor from 16 to 30 percent, while Comeco’s share would fall from 53 to 41 percent, with the remainder staying in the hands of public holders. With its share soaring to US$800 million, this would have made the Kyrgyz state the second largest shareholder after Comeco. The agreement also envisaged a “simplified, stable, and predictable” tax system, amounting to 15-17 percent of the total production, roughly twice the level of previous agreements. Also, a “principled agreement” was achieved, authorizing the government to use its stake to borrow long-term credits to invest into the economy. In exchange, Comeco would be licensed to begin work on an additional 25,000 hectares of land, with estimated gold reserves of more than 700 tons.

The State Finance Police has not still declared the exact sum the gold mine company avoided to pay in taxes since 2003. It accuses the gold mining company of “illegally” benefiting from financial privileges, attained without the parliament’s approval. Nevertheless, the legal grounds of these accusations do not seem to be definitive. Former Prime Minister Tanaev, in his defense, claims that there was no need for the parliament’s approval, since the related parliamentary committee, authorized by the Supreme Court and the Ministry of Justice, had given its consent.

Others, who believe the case is politically driven, assert that it is unlikely that the State Finance Police could act independently, especially in highly sensitive issues such as Kumtor. Besides, the 2008 state budget already includes increased state profits based on the new agreement reached by former Prime Minister Atambaev. Further delays of the agreement would mean the loss of an estimated US$27 million, for which the government could be held accountable.

Apparently, the outcome is precarious and many have come to believe that the government is about to embark on new negotiations with Comeco for conditions more favorable to the state. The new Prime Minister, Igor Chudinov, who referred to the tax investigation as a “normal process,” will surely enjoy parliament’s support.

Analysts exclude the possibility that a change of foreign partner will be forced, considering the high uncertainties involved: the government would have to open new talks from scratch and disregard the debts claimed by the state tax agency. And considering the huge reserves of gold, Comeco is likely to sell its share only for a very high price, which will limit the range of potential investors. Moreover, Finance Minister Akylbek Japarov stated that in case the dispute is to be regulated by the arbitration court, “we [the Kyrgyz government] will lose, since all the corruption machinations were used on our side.”

CONCLUSIONS: It is highly likely that the Kyrgyz government will call for another round of negotiations on Kumtor. An already warmed-up parliament stresses that the Kumtor issue will not be solved until all officials entangled in corruption are charged and illegitimate procedures in previous agreements are discarded. Unlike the awkward experience of the previous leadership, all the branches of powers this time are likely to come up with a single position regarding the “fairness” of arrangements surrounding the gold mine. Nevertheless, when the previous government signed the last agreement, some analysts referred to it as a turning point for the investment climate in Kyrgyzstan, whereas this time, future foreign investors are likely to experience the Kyrgyz leadership’s somewhat awry understanding of commitment to legal agreements.