VII. INVESTMENT CLIMATE A. 1. Openness to Foreign Investment General Overview: An open investment climate has been a key element of the economic transformation process which the Czechoslovak Government initiated shortly after the "Velvet Revolution" in 1989. The transformation process -- including the establishment of an open and stable investment climate -- has continued without disruption in the Czech Republic following the break-up of Czechoslovakia at the end of 1992. The same team of economic policymakers who designed and managed the economic reform program in the Czechoslovak Government stayed on in similar or higher positions in the new Czech Government. The Czechoslovak government focused on improving the investment climate at the initial stages of economic reform in 1990. It was considered to be critical for attracting foreign capital and investment much needed by undercapitalized state enterprises undergoing privatization. Additionally, the Czechoslovaks (and Czechs) have set a high priority on economic integration with the world's advanced economies. The Czech Government has set full membership in the European Union (EU) as its highest priority; and hopes the Czech Republic will become a member of the Organization of Economic Cooperation and Development (OECD) by 1996. Working towards these objectives, the Czechoslovak (and then Czech) Government has welcomed foreign investment from all countries. In an assessment the Czech Government conducted in 1994 with respect to OECD membership criteria, the government determined that Czech legal norms currently meet OECD standards for equal treatment of foreign and domestic investors and restrictions on special investment incentives. Organizational Structure of Investments: Foreign investors can as individuals or business entities establish sole proprietorships, joint ventures, and branch offices in the Czech Republic. In addition, the government recognizes joint-stock companies, limited liability companies, general commercial partnerships, limited commercial partnerships, partnerships limited by shares, and associations. National Treatment: Legally, foreign and domestic investors are treated identically and both are subject to the same tax codes and other laws. By law, the government does not differentiate between foreign versus domestic investors, or between foreign investors from different countries, and does not screen foreign investment projects other than for those few industries described above which are considered sensitive. The government does, however, evaluate all investment offers for state enterprises undergoing privatization. Despite the government's official position of equal treatment, in practice there have been a number of cases in which the government has attempted to "balance out" foreign investment from various countries. Exempted Sectors: In practice, nearly all sectors of the Czech economy are open to foreign investment. Exceptions are all or part of those sensitive industries which the government believes should be kept under at least some measure of Czech control. These include defense-related industries, national and cultural monuments, salt production, and companies involved in the distillation of pure alcohol. At least for the next few years, foreign investment will be limited in the telecommunications sector and in the four largest Czech banks (which have a combined share of about 75 percent of most domestic financial markets). While 100 percent foreign ownership is theoretically possible in all other sectors, there are industries, such as mass media, in which complete foreign control could create local political problems. Investment Incentives: With the exception of some limited tax benefits granted to entice investment into high-priority sectors and some economically depressed regions, the government has strongly opposed special investment incentives. The government considers such incentives to be both unnecessary and ineffective in attracting foreign capital. Ministry of Finance authorities are opposed to special tax incentives because of their effect on government revenues. The limited incentives which are available are granted on an equal basis to both domestic and foreign investors. Under current Czech law, investors may request full or partial exemption from taxation on profits for up to two years after the start of operations. Business representatives and firms may also request exemption from income taxes for one taxation period, although those who invest in the following areas may be exempted from income taxes for a period of two years. This applies to persons or firms engaged in: ecologically-oriented production and services; various health services; some aspects of retail sale; and businesses in northern Moravia, northern Bohemia, and several other regions of the country, such as Kladno, Pribram, Tachov, and Trebic. It must be noted, however, that those firms which seek to defer their taxes are often asked to avoid transferring their profits abroad for the duration of the tax holiday. According to the Czech Government, the only broad package of special investment incentives which the government has granted in the post-Communist era was in 1990. That year, prior to implementation of the large-scale privatization law (which stipulated national treatment for foreign and domestic investors), Volkswagen was granted a series of tax incentives and a temporary protective tariff against imported cars in return for an investment commitment of about $6 billion (subsequently cut to about half) to upgrade the Mlada Boleslav Skoda car factory. The incentives are still in place. With this exception, the Czech Republic currently maintains no discriminatory or preferential export or import policies directed at foreign investors. Complaints of American Investors: Some American companies have complained of distorted conditions in their pursuit of investments in the course of the privatization process. Telecommunications and energy projects are often subject to intense lobbying pressure from foreign governments, and non-transparent or unethical practices are not uncommon at the company level. Additionally, there are licensing requirements for banks, insurance firms, and various other companies wishing to do financial business in the Czech Republic. There are also other industries, such as the electronic media, which have licensing requirements. Other complaints expressed by American firms seeking investment opportunities in the Czech Republic include: the continuing imposition of high taxes, the lack of a transparent bidding process; general slowness of decision-making in the government; excessive red tape; the maintenance of higher tariffs against non-European goods while gradually lowering those against European Community countries as specified in the EC association agreement; and little enforcement of intellectual property rights, particularly copyrights. Additionally, those firms which deal with the Ministry of Privatization complain of the long delays involved in the privatization process, delays so long that the asset values of the properties involved can change significantly. 2. Conversion and Transfer Policies Although the convertibility of the Czech crown is still subject to exchange controls of the Czech National Bank (CNB - the central bank), exercise of the controls is limited; and the crown is, in fact, effectively fully convertible for most business purposes. The CNB and the Czech Government expect the crown to be made full convertible for both current account and capital transactions in 1996 or 1997. Under the Foreign Exchange Act of 1990, domestic or foreign companies in the Czech Republic are guaranteed the right to freely exchange crowns for hard currency in business-related, current-account transactions. Current-account transactions include the import of goods and services, royalties, interest payments and dividend remittances. Repatriation of earnings from U.S. investments is also guaranteed by the U.S.-Czechoslovak bilateral investment treaty which went into effect in December 1992. However, there is currently a 25 percent tax on repatriation of profits from the Czech Republic. Capital account transactions require a foreign exchange license but these are routinely granted. As of early 1994, the Czech National Bank (CNB - the central bank) has also routinely granted business entities permission to hold foreign exchange accounts. Individuals do not need permission to have a foreign exchange account. Additionally, if requested, banks must sell to foreign investors for Czech crowns foreign currency equal to revenue from investment. In this case, "revenue from investment" means income from business profits, interest, capital profits, securities, or intellectual property. 3. Expropriation and Compensation The former communist government of Czechoslovakia had a long history of expropriation and nationalization of property and industries. This practice ceased entirely with the 1989 velvet revolution. The Embassy is unaware of any expropriation of foreign investment having taken place since the revolution. Any acquisition of property by the government is now done only for public purposes (similar to property condemnation in the United States for public works projects, for example), in a non-discriminatory manner, and in full compliance with international law. It is likely that any investors losing property due to expropriation would receive full compensation, although receipt of the actual compensation might take some time due to bureaucratic inefficiency. A related issue, and one much more likely to be encountered by foreign investors in the Czech Republic, is the issue of restitution. In 1990 and 1991, the federal government of Czechoslovakia enacted various laws aimed at compensating those people and firms whose property had been confiscated by the communist regime during the period of 1948-1989. According to recent estimates, as much as 30 percent of all state-owned property and approximately 6 percent of all Czech firms will be affected by the restitution process. Under the restitution law, legal or actual persons have the right to claim compensation for property taken from them by the communist government. All claims for restitution of non-agricultural property had to be filed by October 31, 1991, and agricultural property by December 1992. Because of the large number of restitution claims submitted, it is imperative that foreigners seeking to invest in the Czech Republic first ensure that they have clear title to all land and property associated with potential projects. While the process of tracing the history of property and land acquisition can be complex and time-consuming, it is the only way to ensure clear title. Investors under the privatization process are protected from restitution through the share purchase agreement, a binding contract signed with the government. 4. Dispute Settlement The Embassy is unaware of any disputes between investors and the government or government agencies involving foreign investments which have already been completed. There are a number of ongoing disputes involving U.S. investors and their right to invest in companies or real estate which are currently undergoing privatization, however. 5. Performance Requirements/Incentives There are currently no performance requirements imposed on foreign firms for establishing, maintaining, or expanding their investments or for gaining access to tax and investment incentives. Similarly, there are no requirements regarding the percentage of local ownership or employment, local financing, technology transfer, or amount of exports. There is currently a draft law in circulation regarding tobacco production, however, which would require new entrants in the market to process tobacco domestically as a condition of entry as a cigarette manufacturer. Prospective new entrants in this market have complained that the economics of the domestic market are such that this provision would effectively bar their entry into the market. 6. Right to Private Ownership and Establishment The right of foreign and domestic private entities to establish and own business enterprises is guaranteed by law in the Czech Republic, and is one of the cornerstones of Czech economic reform. Enterprises are permitted to engage in any legal activities with the exceptions noted previously concerning limitations in some sensitive sectors. Personal ownership of real estate by foreigners is not permitted, although this restriction does not apply to foreign businesses. Business enterprises are assured of freely establishing, acquiring, and disposing of all interests within the framework of Czech law. 7. Protection of Property Rights The Czech Republic is bound to the Bern, Paris, and Universal Copyright Conventions. The government is working to ensure that laws for the protection of intellectual property in the Republic match or exceed those of western Europe. Thus, existing legislation guarantees protection of all forms of property rights, including patents, copyrights, trademarks, and semiconductor chip layout design. There is one trademark dispute and one alleged patent infringement which predates the 1989 "Velvet Revolution" and which are the subjects of negotiation between the relevant U.S. and Czech firms and the Czech government. The protection of intellectual property rights remains a problem, however, especially regarding the manufacture and sale of software, and the sale of counterfeit videotapes and designer clothing produced outside the country. Intellectual property protection has been an issue of concern to potential investors in the pharmaceutical industry. The Czech government and local authorities are aware of these concerns and is gradually strengthening enforcement of intellectual property rights. In the meantime, investors should be aware that protection of these rights may not be fully protected until there is stricter enforcement of existing legislation. There have been a few incidents of proprietary information being misused or, allegedly, passed on to competitors in an effort to increase the competitiveness of a tender and thus possibly raise the bids being offered. This could be another area of continuing difficulty until the government creates a suitable privacy act or other general protection of private information. 8. Regulatory System: Laws and Procedures The government of the Czech Republic is committed to the establishment of a free and competitive market. The basic body of legislation which set up the framework for a free market system is the comprehensive commercial code which went into effect in January 1992. The new commercial code replaced approximately 80 assorted codes and regulations, and effectively established the legal framework for most business-to-business activities. This code also brings czech commercial law into compliance with European Community commercial norms. Beyond the commercial code, the most significant legislation passed since 1991 affecting business practices includes the following: a. The banking law created a legal framework for the establishment of commercial banks which moves banking operations towards European Community standards. There will be two amendments to the banking code in 1994 which provides the central bank with stronger supervisory authority and, among other provisions, establishes deposit insurance and mortgage banking. b. The securities law allowed for the formation of financial and stock markets in the Czech republic. c. A tax reform program which has moved the Czech codes more into line with European Community tax policies. Among the provisions most affecting foreign investment are those which established income taxes on worldwide income, social and health insurance taxes on wages, and a European Community-type value added tax. The disadvantages of these taxes are discussed below. d. Laws effectively disbanding all monopolies and setting limits on the commercial use of forests e. A revised bankruptcy law which allows creditors to pursue claims through forced debt restructuring of debtors and ultimately through liquidation. The effectiveness of the new bankruptcy law is still unclear. The large domestic banks (the primary creditors) have been very reluctant to initiate bankruptcy proceedings against the heavily indebted former large state enterprises. There is a three to four year backlog in the bankruptcy courts and there is effectively no secondary market for the liquidation of seized assets. Nevertheless, the bankruptcy law has allowed creditors to effectively put pressure on many debtors to restructure debts and adhere to greater financial discipline. There are several pieces of proposed or existing legislation which are inconsistent with the government's broad philosophy of national treatment. A new public procurement law will be passed in 1994 which may give a 5 to 15 percent marginal price advantage (the exact amount not set as of this writing) to Czech firms bidding on public projects. Additionally, the Association of Czech Accountants has been able to include legislation in the revised 1992 tax law which effectively prevents foreign tax accounts from processing Czech tax returns. 9. Efficient Capital Markets and Portfolio Investment The Czech banking system has been evolving rapidly since 1990, with the number of banks increasing from four in 1989 to 56 by mid-1994. Despite the central bank's liberal policy on bank licensing, the banking sector remains generally non-competitive because the four largest Czech banks, which have assets generated under the Communist banking system, control 70 - 75 percent of the domestic market for most banking services and hold 78 percent of the balance sheets. A second tier of five or six medium-sized banks have seven to eight percent of the market. The remaining banks are very small, new, private domestic banks and foreign banks with specialized niches. The banking sector still faces a number of serious challenges. A significant level of bad debts still exists and banks are reluctant to pursue claims to bankruptcy. Rapid growth of the banking sector has seriously outpaced the availability of trained bank personnel. Banking supervision is also inadequate and there is potential for bank irregularities, especially in the new domestic banks. Despite improvements in the payments clearing system, bank transfers are still relatively slow and those businesses which depend heavily on liquidity may have difficulty receiving their payments on schedule. When deciding on a bank in the Republic, it is recommended that a foreign business representative choose either a branch or subsidiary of a foreign bank, or one of the larger Czech banks with good ties to one with established ties to banks outside of the country. There is some concern about the viability and conduct of small and medium newly established domestic banks. Three first three serious cases of bank fraud occurred in the first half of 1994, largely as a result of liberal licensing and lax banking supervision. While the central bank is tightening up considerably on banking supervision, it is generally expected that there may be additional cases of bank fraud in the small and medium Czech banks. Foreign investors enjoy the same access to credit as domestic Czech business representatives, and viable projects can find appropriate financing at home or abroad. Czech banks tend to appear risk averse due their inexperience with risk analysis, uncertainty about their ability to effectively secure loans, and the shortage of good loan projects. Real interest rates on commercial loans from Czech banks tend to be high. This has attracted a substantial amount of offshore lending for good projects at lower rates than Czech banks are willing to offer. Until 1992, the accounting system used in the Czech Republic was archaic and originally designed to determine whether a given firm had fulfilled its five-year plan. The new Act on Accounting, which came into force in 1992, and the Chart of Accounts and Accounting Procedures for Business Representatives, which came into effect in January 1993, have begun the process of transforming the Czech system of accounting and making it compatible with those in use in western Europe. 10. Political Violence The risk of political violence in the Czech Republic is extremely low. Czechoslovakia never had a history of political violence or terrorism. The "Velvet Revolution" which ended the Communist era in 1989 was achieved without loss of life and with no significant violence. The break-up of Czechoslovakia at the end of 1992 was accomplished without violence or threat of violence. The basic political transition to a democratic and stable government was completed before the break-up of Czechoslovakia in 1992; and the stable, democratic government has been carried forward subsequently by the Czech Government. B. Bilateral Investment Agreements The former government of Czechoslovakia signed a bilateral investment treaty with the United States which entered into force in December 1992. This treaty was carried over by the Czech Republic. In addition, the following countries have signed or are in the process of signing similar agreements with the Czech Republic: Belgium, Luxembourg, Italy, France, Germany, Switzerland, Austria, the United Kingdom, Finland, Sweden, Canada, Spain, Denmark, Norway, Greece, Australia, China, and Thailand. C. OPIC and Other Investment Insurance Programs The Overseas Private Investment Corporation (OPIC) has been operating in the Czech Republic since the signing of a government-to-government agreement with Czechoslovakia in October 1991. This agreement was carried over by the Czech Republic when the country split in January 1993. Under this agreement, the Czech Republic recognized OPIC's subrogation rights, the right to hold, use, and dispose of local currency, the right to nominate a qualified holder of property, etc. D. Labor The general availability of educated, low-cost labor on the doorsteps of the more expensive, western European labor market, is a major attraction for foreign investors, particularly for those looking to invest in labor-intensive industries. Wages, which are only 10-20 percent of those in Germany (as of June 1994) are on the rise, but it is estimated that the Republic will still have lower labor costs in the year 2000 than those found in neighboring industrialized countries. Czech trade unions have generally been ineffective and complacent; there have also been no significant labor unrest since the economic transition started. However, there are reports of growing discontent among miners in the northern portions of the country and farmers in Moravia. While no serious labor disruption is expected from these groups in the near future, they could eventually develop into a source of labor unrest. Workers in the Czech Republic are provided the right by law to form and join unions of their own choosing without prior authorization. Currently, two-thirds of the workers are members of some labor organization, although the overall number of union members has fallen somewhat since 1991. Under the law, all workers are guaranteed the right to strike once mediation efforts have been exhausted; exceptions are those workers (nuclear power plant operators, military, police, etc.) in sensitive positions who are forbidden to strike. The Federal Ministry of Labor and Social Affairs sets minimum wage standards to guarantee an adequate standard of living for a worker and, with special allowances, for his family as well. A standard workweek of 42.5 hours was mandated by law, but collective bargaining has brought closer to 40 the actual number of hours worked. Additionally, caps exist for overtime and workers are assured at least 30 minutes of paid rest per work day, and annual leave of three to four weeks per year. The basic minimum age for employed children is 16. Exceptions are made for 15 year-olds who have already finished elementary school and for 14 year-olds who have completed courses at special schools for the disabled. As far as the U.S. Embassy can determine, all of the above workers' rights are applied to firms with foreign investment and do not differ from those in place in other sectors of the economy. There are no restrictions on the use of foreign workers in the Czech Republic, although the process of obtaining the various required permits may take a few months, during which workers are permitted to take up employment. E. Foreign-Trade Zones and Free Ports Czech Republic law permits foreign investors involved in joint ventures to establish a commercial or industrial free-customs zone into which goods may be imported and later exported without depositing customs duty. This duty need be paid only in the event that the goods brought into the Czech Republic are circulated in the local economy. There are currently six foreign trade zones in the Czech Republic: Cheb, Kosice, Ostrava, Pardubice, Prague, and Zlin. Applications to establish a commercial or an industrial customs-free zone within one of these areas are made to the relevant government ministry. F. Capital Outflow Policy There are no laws or policies in the Czech Republic which would impede or encourage the outflow of capital or direct investment in developed or developing countries. However, there is currently a 25 percent tax on repatriated earnings. Other than this tax, there are no barriers to the flow of capital out of the country and none are expected to be erected in the near future. G. Foreign Direct Investment Statistics Between 1990 (when significant foreign investment started) and the end of 1993 the Czech Republic received just over USD 2 billion in foreign direct investment (FDI). As of the end of 1993, Germany was the largest investor, with 31.2% of FDI in terms of value, followed by the United States (27.8%), France (12.7%) and Belgium (7.2%). By sector, the largest share of FDI was in consumer goods and tobacco (26.0%), followed by transport equipment (20.3%), construction (12.8%), foodstuff (9.8%) and banks (10.1%). The flow of FDI peaked in 1992 with a $1.2 billion inflow associated with the first of two waves of large-scale privatization. With the establishment of capital markets in 1993 and the gradual completion of the privatization process, the focus of foreign interest is shifting towards portfolio investment and foreign loans. The second wave of large-scale privatization is underway and will be completed in mid-1995. Since more problematic enterprises are being privatized, there is likely to be less interest by foreign investors than there was in the first wave. Economists estimate that the Republic could absorb approximately USD 1.5 billion annually in foreign capital over the course of the next several years in order to restructure the industries, rebuild infrastructure, and generally put the economy on a sound footing. The following is a table of inflow from the chief foreign investors into various industries of the Czech Republic as of the end of 1993. The information is from an official Czech government publication. Country Branch of Industry * (in million U.S. dollars) 1 2 3 4 5 6 7 8 Germany 60 180 600 25 200 10 5 280 USA 1.6 14 320 20 70 17 40 France 1.6 310 15 18 120 120 Switzerland 30 40 17 2 11 8 9 70 Belgium 2.5 .8 20 150 Austria 55 20 16 10 31 *Explanation of Industries: 1. Metallurgy 2. Investment Engineering 3. General Engineering 4. Electronics, Electrical Engineering 5. Chemical Industry 6. Light Industry 7. Wood-Processing Industry 8. Building and Building Materials Industry H. Major Foreign Investors Volkswagen AG, Germany Nestle/Danone, Switzerland/France Philip Morris, USA KMart Corporation, USA Ford Motor Company, USA Linde, Germany Siemens, Germany Procter & Gamble, USA Unilever, Netherlands Coca Cola, USA Renault VI, France Johnson Controls, USA