Report No. 2201 3-TJ Taj ikistan Towards Accelerated Economic Growth A Country Economic Memorandum January 5, 2001 Poverty Reduction and Economic Management Europe and Central Asia Region Document of the World Dank ABBREVIATIONS ADB Asian Development Bank ADT Average Daily Traffic AKDN Aga Khan Development Network C Centner (Hundredweight) CADA United States Central Asian Development Agency CSFB Credit Suisse First Boston DOTC Department of Transport and Conmmunications ECA Europe and Central Asia Region FDI Foreign Direct Investment FSU Former Soviet Union GBAO Badakhshan Province GDP Gross Domestic Product (value added) HIPC Heavily Indebted Poor Countries Initiative HA Hectare KM Kilometer KWH Kilowatt-Hour IFC International Finance Corporation ISP Internet Service Provider LPG Liquefied Petroleum Gas MOTR Ministry of Transport and Roads MTEF Medium Term Expenditure Framework NBT National Bank of Tajikistan O&M Operations and Maintenance PIP Public Investment Program RRS Rayons of Republic Subordination SME Small and Medium Enterprises SOE State-Owned Enterprise SPC State Property Committee TACIS Technical Assistance Project for CIS Countries TADAZ Tajik Aluminum Plant TASIF Tajik Social Investment Fund TFP Total Factor Productivity TLSS Tajikistan Living Standards Survey TR Tajik Ruble TRACECA Europe-Caucasus-Asia Transport Corridor VAT Value Added Tax VPD Vehicles Per Day WFP World Food Program WTO World Trade Organization WUG Water User Group CURRENCY EQUIVALENTS FISCAL YEAR Currency Unit = Tajik Ruble (TR) January 1 - December 31 Exchange Rate (March 31, 2000) = TR 163 1/US$ Vice President: Johannes Linn Country Director: Kiyoshi Kodera Sector Director: Pradeep Mitra Team Leader: Cevdet Denizer TABLE OF CONTENTS PREFACE EXECUTIVE SUMMARY i Sustaining Macroeconomic Stability ii Growing and Moving Toward a Market Economy: A Medium Term Strategy iii Enterprise Adjustment and Private Sector Development iv Agriculture vi Banking and Finance viii Telecommunications x Transport xii Conclusions xiv CHAPTER 1: Macroeconomic Overview and Growth Strategy 1 Introduction I Macroeconomic Overview I Output Performance 1 GDP per capita 2 Savings and Investment 3 Sectoral Structure of GDP 3 Foreign Trade 4 Monetary Policy and Price Developments 5 Fiscal Management 7 External Debt 8 Medium Term Expenditure Program and Public Investment Program 10 Medium Term Growth Strategy 10 Productivity and Economic Growth in Tajikistan 11 Productivity, Poverty, and Growth II The Importance of Productivity and Productivity Trends 11 Sector TFP Trends 13 Restructuring, Productivity, and Output Growth 14 Medium Term Growth Prospects 16 CHAPTER 2: Enterprise Adjustment and Private Sector Development 17 Tajikistan's Industrial Landscape 17 Size and Sectoral Composition 17 Industrial Growth and Performance 18 Employment Adjustment 19 Regional Patterns 19 Foreign Trade 20 Enterprise Ownership 20 Pace and Quality of Enterprise Adjustment 21 Excess Productive Capacity and Reallocation of Capital Assets 21 Pace of Privatization and Corporatization 22 Privatization/Corporatization and Competitive Restructuring 22 Incentive Regime 23 Price Signals 23 Subsidies, Offsets, Barter, and Directed Credit 24 Weak Competitive Environment, Market Segmentation, and Infrastructure 24 The Importance of the Energy Sector for Private Sector Growth 26 Distortions that Limit Export-Led Growth 27 Taxation 27 Foreign Direct Investment 28 Market Institutions 28 Regulatory and Competition Policy Framework 28 Corporate Governance Incentives 29 Exit of Nonviable Firms and External Discipline through Bankruptcy 31 Opportunities for Discretion and Corruption 31 Access to Competitive Finance and Credit 32 Priority Policy Recommendations 32 CHAPTER 3: Agriculture 35 Sector Endowments and Recent Performance 35 Cropping Patterns 36 Livestock 37 Relative Prices and Demand 37 Consumer Demand 37 Regional Patterns of Demand 38 Farm Production Systems and Sector Restructuring 38 Recent Farm Restructuring 38 Dehqan Farms 39 Lease Arrangements 40 Household Plots 40 "Presidential Land" 40 Regional Patterns in Farm Restructuring 41 Patterns of Production and Productivity among Farm Types 42 Variable Inputs 43 Cotton and Inputs 43 Input Availability 44 Labor Issues 44 Labor, Restructuring, and Productivity 44 Labor Intensity 45 Wages and Other Income 45 Irrigation 46 Irrigated and Dryland Crop Area 46 Institutions 46 Operations and Maintenance 47 Lift Irrigation 47 Market Incentives to Improve Efficiency and Increase Cost Recovery 48 Rural Finance 48 Financial Institutions and Performance in the Cotton Sector 48 Credit Outside the Cotton Sector 49 Output Markets and Processing 50 Information and Communication 50 State Purchasing 50 Bazaar Trade 51 Agro-processing 51 Potential 52 Restructuring Farm Production Systems 52 Growth Scenarios 53 Policy Options for Short Term and Medium Term Growth 54 CHAPTER 4: Banking and Finance 57 Operating Environment 57 Banking Sector Performance 60 Sector Structure and Financial Results 60 Directed Credits and Bad Loans 61 Bank Restructuring Outcomes and Issues 62 Corporate Governance 63 Regulatory Compliance 63 Legal and Regulatory Framework 64 Instruments and Products 65 The Payment System 66 Largest Banks 66 Policy Issues and Recommendations 69 CHAPTER 5: Telecommunications and Informatics 72 Sector Structure 72 Sector Restructuring 72 State Ownership 73 Restrictions upon Entry and Competition 73 Sector Regulation 74 Legal Framework 74 Licensing 74 Lack of Interconnection and Revenue Sharing Agreements 75 Taxation 75 The Telecommunications Operator Association 75 Sector Performance 76 Supply and Demand 76 Inefficient Allocation of Capital Assets 77 Disparities in Access 78 Service Quality 78 Telephone Network Structure and Technology 78 Maintenance 79 Long Distance Network 79 Cellular Services 79 Trunking 80 Internet 80 Human Resources 81 Financial Viability 81 Budgeting 81 Low Revenues 82 Prices 82 Accountability 83 Conclusion 84 CHAPTER 6: Transport 87 Demand 87 Transport Intensity of Freight 87 Patterns of Demand for Freight 88 Passenger Transport 88 Intemational Transport and Foreign Relations 89 Supply 9 1 Infrastructure 9 1 Fleet 92 Institutional and Legal Framework 94 Organizational Structure 94 State Ownership and Sector Management 94 Legal Framework 95 Transparency and the Law 96 Financial Viability 96 Subsidies and Price Controls 96 The Road Fund 97 Rail and Air Transport Revenues 97 Potential 98 Freight Transport 98 Passenger Transport 98 Growth Scenarios 98 Recommendations 99 CHAPTER 7: Medium Term Growth Prospects and External Debt 102 Economic Growth 102 External Sector and Extemal Debt Sustainability Issues 104 Budgetary Effects of Debt Service Costs and Social Expenditures 107 STATISTICAL ANNEX Index of Tables Table 1.1: Macroeconomic Indicators, 1992-99 Table 1.2: GDP per Capita, 1995-99 Table 1.3: Terms of Trade, 1995-99 Table 1.4: Projected External Financing Commitments 2000-03 Table 1.5: TFP Trends in Tajikistan's Economy, 1991-98 Table 1.6: Sectoral TFP Trends Table 1.7: TFP Within Sector and Share Effects, 1991-98 Table 3.1: Number of Farms and Estimated Arable Areas, 1998 Table 3.2: Yields by Farm Type, 1995-98 Table 3.3: Machinery in Agricultural Enterprises, 1998 Table 3.4: Number Employed in Agriculture by Farm Type, 1992-98 Table 4.1: A Snapshot of the Banking Sector (1998-99) Table 4.2: Indicators of Financial Depth in ECA Countries, 1997 Table 4.3: Consolidated Balance Sheet of the Banking System, 1997-99 Table 5.1: Access to Communications Infrastructure Table 5.2: Regional And Urban/Rural Disparities in Telephone Service Table 6.1: Public and Private Freight, 1999 Table 6.2: Transport of Types of Freight by Rail, 1992-98 Table 6.3: Passenger Transport by Public Enterprises, 1992-98 Table 6.4: Public Transport Fleet, 1992-98 Table 7.1: Sustained and Truncated Reforms: 2 Scenarios Table 7.2: Debt Service Capacity under Sustained Reform Scenario, 1999-2010 Table 7.3: Social Expenditures and Debt Service Index of Figures and Charts Figure 1.1: Sectoral Composition of Value Added Figure 1.2: CPI Inflation and Exchange Rate, 1996-2000 Figure 1.3: Fiscal Position of the Government, 1995-1999 Figure 1.4: External Public and Publicly Guaranteed Debt and Debt Service Due, 1992-2004 Figure 2.1: Industrial Output - Extracting vs. Processing Figure 2.2: Regional Variation in Industrial Output Figure 3.1: Output, Employment, and Productivity in Agriculture, 1991-98 Figure 3.2: Structure of Arable Area Figure 3.3: Yields Figure 3.4: Sown Area of Farm Types by Province Figure 3.5: Agricultural Production by Farm Type Figure 3.6: Sown Cropland, 1992-98 Figure 4.1: Real Interest Rates, December 97 - January 2000 Figure 4.2: Deposits of the Banking System, February 1997 - January 2000 Figure 5.1: Telecommunications Sector Ownership Figure 5.2: Telecommunications Sector Structure Today Figure 5.3: Low Income Telephone Penetration in 1998 Figure 5.4: Low Income Countries Internet Penetration in 1998 Figure 5.5: Telecommunications Revenue Per Main Line Figure 6.1: Length of Roads in 1998 Chart 7.1-2: Debt Sustainability Indicators under Sustained and Truncated Reform Scenarios Index of Figures Figure 1.1: Sectoral Composition of Value Added Figure 1.2: CPI Inflation and Exchange Rate, 1996-2000 Figure 1.3: Fiscal Position of the Government, 1995-99 Figure 1.4: External Debt and Debt Service Due, 1992-2003 Figure 2.1: Industrial Output - Extracting vs. Processing Figure 2.2: Regional Variation in Industrial Output Figure 3.1 Output, Employment, and Productivity in Agriculture, 1991-98 Figure 3.2 Structure of Arable Area Figure 3.3 Yields (1992-98) Figure 3.4 Sown Area of Farm Types by Province, 1998 Figure 3.5 Agricultural Production by Farm Type, 1998 Figure 3.6 Sown Cropland, 1992-98 Figure 4.1: Real Interest Rates, December 97-January 2000 Figure 4.2: Deposits of the Banking System, Feb. 1997 - Jan. 2000 Figure 5.1: Telecommunications Sector Ownership Structure Figure 5.2: Telecommunications Sector Structure Figure 5.3: Low Income Countries - Telephone Penetration, 1998 Figure 5.4: Low Income Countries - Internet Penetration, 1998 Figure 5.5: Telecommunications Revenue / Main Line Figure 6.1: Length of Roads, 1998 Index of Boxes Box 1.1: Growth Accounting and Productivity Box 2.1: State Committees/Corporations on Industry; Consumer Goods & Services; and Food Processing Box 2.2: Profiles of Three New Entrants Box 4.1: The Payment System Box 6.1: Security and Surveillance in the Transport Sector: Contraband Box 6.2: Security and Surveillance in the Transport Sector: Checkpoints PREFACE This Country Economic Memorandum (CEM), Tajikistan: Towards Accelerated Economic Growth, is a collaborative venture between the Govermment of Tajikistan and the World Bank and was prepared by a World Bank team on the basis of discussions held and data obtained during a mission to Tajikistan in February-March of 2000. The World Bank prepares a comprehensive economic study on each of its client countries every 3-4 years. The last such economic study for Tajikistan was completed in 1996. This CEM provides an overview of Tajikistan's recent progress towards a market economy and outlines a medium- term reform agenda aimed at sustaining macroeconomic stability and further accelerating economic growth. Together with the Poverty Assessment produced in early 2000, the CEM provides the analytical foundations for the preparation of a fully-fledged Poverty Reduction Strategy for Tajikistan. The authors of the CEM gratefully acknowledge support of Tajik officials, including those from state industrial companies and corporations, who provided excellent cooperation in the preparation of the CEM. Special credit should be given to the State Statistical Agency, National Bank of Tajikistan, Ministry of Economy and Foreign Economic Relations, and Ministry of Finance. The CEM recognizes the tremendous strides Tajikistan has made both in achieving national reconciliation and turning the economy around over the past 4 years. Yet the study finds that important structural distortions persist in a number of sectors of the Tlajik economy, preventing the reallocation of underutilized capital and labor to more productive uses and keeping output and incomes below their potential. The CEM identifies such distortions in industry, agriculture, and banking and proposes short and medium term measures to address them. Special attention in the CEM is devoted to restructuring and enhancing capacity in telecommunications and transport, since these two sectors will play a key role in integrating Tajikistan more closely into the world economy and offsetting some of the disadvantages of the country's remote geographical location. The CEM team was led by Cevdet Denizer (macroeconomic overview, growth strategy, and medium term prospects and external debt). Other contributors to the report were Harry Broadman (enterprise restructuring), Jacques Bure (transport), Mark Lundell (agriculture), David Grigorian (banking and finance), Monika Hencsey (telecommunications), Andriy Storozhuk (macroeconomic overview and enterprise restructuring), Mike Thurman (agriculture, transport, and overall editing), Thirumangalam Sampath (agriculture), Subramaniam Janakiram (agriculture), Giuseppe Fantozzi (agriculture), Svetoslav Tintchev (telecommunications), and Waly Wane (taxation). The peer reviewers were Helga Muller and Hongjoo Hahm. The CEM team is thankful to Samuel Otoo, Ataman Aksoy, and Christian Petersen for their valuable comments and guidance throughout the CEM process. EXECUTIVE SUMMARY 1. Peace and renewed reform efforts have brought stability and economic growth. The signing of a peace agreement between the Government and the United Tajik Opposition in mid-1997 enabled the authorities to focus on reforms. The implementation of the reform program developed with the IMF and World Bank assistance in 1996 was resumed, with reasonably significant achievements to date, and inflation was successfully controlled. The Government completed small scale privatization and initiated the reform of large scale enterprises in 1999. It also intensified efforts to reform agriculture-by 2000 usage rights to almost half of the arable land had been transferred to private farmers. Financial sector restructuring began in 1998. As a result of this reform package and a more stable political situation, GDP started to grow in 1997. The GDP growth rose to 8.3 percent in 2000 bringing the cumulative growth rate between 1997 and 2000 to 20 percent. 2. The main challenge that lies ahead is to reduce poverty through economic growth. The World Bank's recent Poverty Assessment Report shows that the severe contraction of output between 1991 and 1997 was associated with a rapid rise in poverty. According to various estimates, 60-80 percent of the population now live in poverty. With an estimated per capita GNP of about $290, Tajikistan is the poorest country in the former Soviet Union (FSU). Thus, it is critical to sustain and accelerate economic growth to reduce poverty-the goal of this Country Economic Memorandum (CEM) is to help the Government develop a set of policies to achieve this objective. The report focuses on productive economic sectors such as industry and agriculture, which, as shown in the figure below, contributed less to GDP in 1995 than at present. The importance of the power sector is also briefly noted. Other key sectors, such as finance and banking, telecommunications, and transport, are reviewed due to their importance for the expansion of domestic economic activity and regional and international trade. 3. There are many remaining Sectoral Composition of Value Added (GDP) tasks, and much needs to be 100% done to accelerate growth. 1 Macroeconomic stability is still 80% fragile, and due to low tax revenues and growing foreign debt service requirements, fiscal 6 sustainability is a source of 4 concem. Because of civil strife, 40l1 _ the implementation of structural 20% reforms in the key sectors of the economy was delayed, making 0I Tajikistan's economy one of the 1995 1998 1999 least reformed among the ;dires SerAke. OCenstrWn *Agrkulfwetndforeetry nfndus"ry transition countries. The share of the private sector is the second Source: Goskomstat. lowest in the FSU, market institutions are weak, and there are Executive Summary ii significant distortions that hamper growth. Therefore, the Government should deepen and broaden reforms in the main sectors of the economy and further develop market institutions. Following a macroeconomic overview, this executive summary outlines a set of policies in each sector, emphasizing the linkages between them, and proposes short and medium term measures that can accelerate economic growth. 4. Tajikistan has the potential to produce significantly more output with little additional investment if its existing human and physical capital are used more efficiently in the medium term. The adoption of the policies recommended in this report would facilitate the movement of capital and labor across and within sectors towards their optimal use, thereby facilitating a rise in productivity. The gains in each sector would be large, potentially adding as much as 5 percent to GDP growth on an annual basis over the next 4-5 years, barring natural disasters and/or political instability. Such a strategy is also likely to generate more investment to sustain economic growth in the long term. SUSTAINING MACROECONOMIC STABILITY 5. Credibility and consistency in monetary policy is key for stability. The tightening of Tajikistan's monetary policy stance in late 1997 brought a degree of stability in 1998. Inflation was reduced from 163 percent in 1997 to about 3 percent in 1998, due to strengthened financial discipline. However, the Russian crisis introduced an external shock, prompting the National Bank of Tajikistan (NBT) to increase directed lending to the government in late 1998. The shock led to the depreciation of the Tajik ruble by 50 percent (August 1998-August 1999) and contributed to inflation of over 30 percent in 1999. Periods of monetary tightening have been interrupted by reversions to inflationary budget financing and allocation of directed credits to state enterprises and farmers. Inflation increased in 2000, in part caused by a temporary depreciation that occurred soon after the introduction of new currency, the Somoni, and it exceeded 60 percent for the year. However, January 2001 figures suggest inflation is moderating. The fragile nature of economic stability is reflected in low confidence in the currency- the share of broad money to GDP is presently about 5 percent. In the afternath of the Russian crisis, monetary policies should demonstrate consistency over time to establish and maintain credibility, while the policy stance needs to remain tight to further support financial discipline in the economy and ensure a viable external position. 6. Government revenue mobilization should be improved and foreign debt carefully managed. Public finances are strained, which, together with low revenues and growing foreign debt service requirements, makes fiscal sustainability an issue. Although budget revenues grew slightly in the past two years, these are still low (at 13.5 percent of GDP). The Government has already reduced expenditures, and there is not much room for further cuts in the budget. The situation will become more difficult, owing to the fact that debt repayments on about $ 0.9 billion of public debt stock will accrue to an average of almost 6-7 percent of GDP on an annual basis for the next 4-5 years unless these payments are rescheduled. Over the last 4 years, Tajikistan could pay only a portion of debt due, amounting to 1 percent of GDP. The country is already in arrears with creditors. The burden of debt on public finances is particularly heavy, with the ratio of Executive Summary iii the present value of debt to consolidated government revenues exceeding 400 percent at the end of 1999, far above the Modified HIPC threshold of 250 percent. While there have been reschedulings with some of the creditors, these have not been sufficient, and in some cases the termns were worse than before. This makes another round of debt reschedulings on concessionary terms an important item of Tajikistan's development agenda. GROWING AND MOVING TOWARD A MARKET ECONOMY: A MEDIUM TERM STRATEGY 7. The acceleration of economic growth requires simultaneous effort in the main sectors of the economy. With a unified Tajik Government established after the elections in March of 2000, the authorities can begin the next stage of economic transition, which will involve sectoral restructuring and further developing the legal and regulatory framework needed for a market economy. Sectoral reforms need to be implemented in tandem and in a well sequenced manner. This is because the effectiveness of reform in one sector is often dependent on the success of reform in other sectors of the economy. These linkages should be accounted for by sequencing and coordinating reform in and among the various sectors. For example, developing a sound financial system can eliminate bottlenecks in credit markets in every sector of the economy. However, improving the financial system requires solving the bad debt problems of the banking sector, which in turn requires enterprise reform and avoiding the use of directed credit. 8. Sequencing of reforms is important. Agricultural reforms need to be the priority in the short run as this sector has the highest potential to reduce poverty. The analysis carried out in this report indicates that it is possible to improve yields significantly if reform policies outlined in the report are implemented in the sector. Policy actions in the private sector development area and the financial sector should be implemented simultaneously as these are closely linked. Given that most of small enterprises are now in private hands, the focus of attention needs to be on medium and large enterprises. In this context, the existing privatization program should be converted into a three year strategic privatization plan and deal with the privatization of large enterprises on a case by case basis. Financial sector reforms need to be deepened and the focus should be on the operational restructuring of banks and exit of poorly capitalized banks with policy measures building confidence in the system. 9. One of the key factors that would contribute to sustained growth is an enabling business environment that facilitates new business entry. Experience in other transition economies shows that it is the formation of new businesses that drives economic growth rather than privatization and restructuring of existing enterprises. In other words, the policy framework should strongly support entrepreneurs and encourage new business formation. In this context, it should be noted that a critical factor that would support private sector growth is the regulatory framework. Licensing and other regulations should be liberal and kept to a minimum but enforced properly. A relevant factor in this connection is access to commercial courts. Current regulations make it too expensive to approach to commercial courts to settle disputes and this hinders the development of the private sector. Ensuring that business community is knowledgeable Executive Summary iv about their rights under the law is also important and the authorities should attach importance to this matter 10. Commercialization of and increased private sector involvement in transport and telecommunications can be achieved in the next couple of years and contribute to economic growth. The movement of goods and people in all sectors of the economy depends upon efficient transport. A functional system of transport is also required to reap the benefits of regional trade, which can be expected to rise with greater political stability in Tajikistan. Developing the telecommunications sector would enable businesses and individuals to transmit information more easily, which is needed for the expansion of markets and to increase economy-wide efficiency. This is also a prerequisite if Tajikistan is to be part of the globalization process and improve its access to world markets. Further development of these two important sectors is possible only with greater private sector involvement, given the tight budgetary conditions. The Government should include the privatization of the telecommunications operator and commercial functions of the transport ministry under the strategic privatization program noted above after regulatory infrastructures are put in place. 11. For sectoral reforms to succeed, they must be guided by several key principles. With a degree of macroeconomic stability achieved, several critical aspects of policy measures should be emphasized to support sectoral restructuring and institutional development. These include: (i) transferring ownership from the public to the private sector through the privatization of public assets; (ii) adopting regulations to encourage new business formation and ensure a level playing field for all market participants, as well as monitoring monopolies and uncompetitive behavior; (iii) ensuring the effectiveness of price signals by eliminating informal production quotas and avoiding excessive bureaucratic controls; (iv) curtailing arrears between enterprises and to and from the state budget; and (v) assuring proper govemance by implementing rules and regulations fully and evenly to minimize rent seeking behavior. These factors are associated with productivity growth in transition economies, and they are used as the guiding framework for the sectoral assessments below. Enterprise Adjustment and Private Sector Development 12. Adjustment in the enterprise sector is at an early stage, and significant excess capacity remains. M enterprises lost their economic viability following a sizeable change of relative pi }, a sharp drop in demand, and the collapse of FSU trade arrangements. According to official data, the output of industrial enterprises is 40 percent of its 1991 level, in some sub-sectors even lower. A recent World Bank survey shows that on average enterprises were operating at 18 percent of capacity in early 2000. Employment has declined by one-half since 1991, which has been the main mechanism of adjustment in the sector. The survey also indicates that enterprises have been doing little to deal with their unused fixed assets-only 19 percent of the surveyed firms had sold existing plant, equipment, and machines, and only 18 percent indicated they had made purchases of new equipment to replace obsolete fixed assets. Thus, the reallocation of capital towards more productive uses has not occurred. Sub-optimal use of capital assets inhibits economic growth. Executive Sammary v 13. While the privatization of small-scale enterprises is virtually complete, a majority of medium and large enterprises still belong to the state, and industry is dominated by public firms. The Government was successful in privatizing most small enterprises, especially in the retail trade and services. Progress in large and medium enterprises was slower. By March of 2000 all of these enterprises had been corporatized, but only 140 of 750 of them had been privatized. In part, this is due to the fact that the initial asking prices set by the Government were generally too high for the market, in effect fulfilling the function of reservation prices. The Government also has ownership in medium-sized firms where over 25 percent of shares are owned by the state. Of the firms surveyed by the Bank, 54 percent were wholly state-owned, 17 percent were privately owned, and 22 percent were of mixed ownership. Taken together, the share of the public sector in industrial value added could be as large as 80 percent, one ol the highest percentages in the FSU. 14. Enterprise restructuring should be encouraged and intensified. Privatization and corporatization did not lead to competitive restructuring, whether in terms of shutting down idle capacity or shedding surplus assets. It appears that in most cases the privatized assets were acquired by insiders, usually the manager or several employees, who do not have the funds to restructure the enterprise. A Govermment decree in early 2000 ordered idle state-owned enterprises to be placed in "conservation," which will negatively affect the reallocation of enterprise assets to their best potential use and the reduction of excess capacity. Bankruptcy laws, which were enacted in 1992 and amended several times thereafter, need to be enforced. From 1997 to 1999, while 100 insolvency cases were considered by the SPC, only 3 cases-all involving small state-owned enterprises-were tried in court. Only 4 percent of firms surveyed indicated that creditors threatened them with bankruptcy suits. 15. The incentive regime is weakened by several other factors, and a coherent policy to eliminate distortions should be developed to support the private sector and raise overall efficiency in the economy. Formally, most prices governing business and consumer transactions in Tajikistan have been liberalized. However, the extensive use of subsidies, directed credits, barter, and arrears undermines the effectiveness of price signals. While explicit subsidies through the budget constituted 0.8 percent of GDP, arrears on wages and pensions amounted to 1.9 percent of GDP in 1999. During 1999 lending by the National Bank of Tajikistan to privatized firms increased by 55 percent of reserve money, of which finance for cotton production accounted for 60 percent of NBT directed credits. Among the firms surveyed by the Bank, the incidence of barter increased from 28 to 53 percent of sales between 1993 and 2000. Another factor is the vertical and horizontal linkages between large state firms, which appear to enjoy structural market power. There is some evidence that the vertical integration of certain processing industries and wholesale trade is undermining competition, which requires the attention of regulators. 16. Market institutions are in the early stages of development, and private sector formation is proceeding slowly. The share of the private sector in Tajikistan's economy is around 30 percent of GDP, which is the second lowest in the FSU. While further privatization of public assets will increase that share, creating conditions for "greenfield" Executive Summary vi entry of new start-ups, especially in agro-processing, requires immediate emphasis. According to official data, there are over 100,000 registered individual entrepreneurs and close to 2,000 small businesses operating in Tajikistan, which, on a per capita basis, is low in comparison with other transition countries. While there have been improvements in licensing requirements existing regulations could be further streamlined with a view to encourage the formation of new businesses. The difficulty of obtaining financing was particularly emphasized in the Bank's enterprise survey. Moreover, subsidies, arrears, and directed credits, and vertical and horizontal integration of retail distribution and in some cases unjustified audits by tax inspectors also create an uneven playing field for the private sector and retard its development. 17. Facilitating adjustment in the enterprise sector requires action in a number of areas. Accelerating growth and further moving toward a market economy requires pressing ahead with the privatization program that was originally developed in 1991. Privatization of large enterprises has been delayed already, and, with political stability achieved, it should be completed in the near future. For this purpose, the Government should drop reservation prices and switch to cash flow-based valuation from the current balance sheet-based valuation, which results in unrealistic prices for the enterprises to be privatized. As reforms progress it will be important to privatize the large state firms in the key sectors such as telecommunications, transport, as well as TADAZ. In this connection, the existing privatization plan needs to be turned into a strategic plan under which the privatization of large enterprises could be implemented on a case by case basis with the participation of foreign investors. 18. Bankruptcy is a key mechanism in resource allocation-existing regulations should be enforced. As currently implemented, the bankruptcy law in Tajikistan is of little use. Despite its negative connotation, bankruptcy is a market institution and should be seen as such. Transferring assets from low to high productivity areas will be greatly facilitated if bankruptcy laws are enforced. 19. Power sector reforms need to be implemented. A reliable power supply is critical for supporting economic development. There has been no new investment in the facilities of Bark-i-Tajik, the state-owned electricity company, since independence. The infrastructure is rapidly deteriorating. Power blockages are common, and the current situation is not sustainable. Tariffs are not enough to cover marginal costs, and even at those rates the cash collection rate for households is about 60-65 percent. The corresponding figure for industry is even lower, at about 20 percent, which has been mostly due to non-payments by TADAZ. A payment schedule for the elimination of arrears by TADAZ has been agreed upon between TADAZ management, the Government, and Asian Development Bank as part of a medium terms sector strategy and this should be adhered to ensure the financial viability of Bark-i Tajik. Due to widespread poverty, the Government is planning to raise collection rates for households to 70 percent by July of 2001 and achieve a 100 percent collection rate thereafter which has implications for the design of social programs aimed at protecting the poor from significant price adjustments in this area. 20. The regulatory framework should be substantially strengthened over the medium term . In order to fully develop a credible competition "champion"-one with Executive Summary vii teeth-within the Government, the organization, structure and functions of the new established Anti-Monopoly and Entrepreneurship Committee responsible for competition and regulatory policy-making and enforcement should be substantially strengthened. The new agency should develop its work program quickly and hire new staff and begin arranging for their training. Technical assistance needs are large and donor funding for this purpose should be sought by the agency. To effect greater public cornmitment to implement competition policy in a de-politicized fashion, reduce apparent conflicts of interest, and have the clout to deal with powerful vested interests, both on an inter-agency basis and within the economy at the central and local levels, there is a need to break from the past and aim for developing a strong agency that can implement the "'rules of the game". There is a not a single model for restructuring the agency, but international practice suggests a set of principles upon which the agency should operate, including, but not limited to: decisions should be rules-based; the entity's budget should be financially autonomous from other ministries; there should be a transparent appeals process for consumers and businesses, including public hearings; the agency should have autonomous regulatory authority, including issuance of regulations; and the agency's performance should be subject to regular public monitoring to ensure the public interest is protected. 21. Several actions can significantly enhance the efficiency of the regulatory process and reduce opportunities for corruption. These include (i) De-politicization: and use of independent regulators and judges are critical to ensuring impartiality of regulatory decisions. The term/tenure of regulatory officials should be made immune from the political process/cycle; (ii) Reduction of discretionary behavior in implementing regulations: Achieving this objective will necessitate strengthening the legislation that defines the rules-based regime and enforcing incentives/disincentives for officials to adopt stricter adherence to that regime. Streamlining the business licensing and registration decision-making process will also reduce opportunities for discretionary conduct by regulators; (iii) The content of the regulations should ensure that they create a "level playing field" among users so as to not provide for cross-subsidies and unfair advantages, especially between SOEs and private firms; and (iv) Safeguards should be put in place that increase the public transparency and accountability of all regulatory decisions. Agriculture 22. Tajikistan's agricultural sector faces many challenges. Agriculture has borne the brunt of the structural adjustments caused by the contraction of industry and other sectors of the economy. In the short term this was unavoidable as people struggled for subsistence. However, labor productivity has declined tc, 35 percent of 1991 levels due to the sector's absorption of increasing numbers of people, the collapse of input supply, and the increasing involvement of many farmers in subsistence rather than commodity production. Given the fixed amount of land, raising farm productivity and restructuring are critical. A major challenge for the Government is to reduce its fiscal reliance on cotton, eliminate informal coercion to produce it, and make it a more profitable crop for the farmers. Executive Summary viii 23. Farm restructuring proceeded significantly in the late 1990s. By the end of 1998 the Government had transferred 41 percent of all sown area to the population as household plots (198,000 ha.), in the form of a lease (100,000 ha.), or as a private, family-run "dehqan" farm (46,000 ha.). Dehqan farmers typically receive disproportionate amounts of arable land. The process of converting collective farms to dehqan farms is dominated by farm and district (rayon) officials who tend to allocate lands in a less than transparent manner. The formation of dehqan farms should be subject to close scrutiny and always address why a disproportionate amount of land is being given for use by a particular family. Among the regions of the country, farm restructuring is most advanced in Badakhshan and the Rayons of Republic Subordination, while reforms have lagged behind in Khatlon and Leninabad Provinces, where powerful vested interests in the cotton sub-sector are reluctant to relinquish control of farm operations. 24. Though the cotton sector has officially been deregulated, cotton production quotas are still imposed informally via local officials, and supply of inputs is contingent upon their fulfillment. A centrally imposed 23 percent excise tax combines with the poor cash flow of the country's 23 cotton ginneries to make the actual returns paid to cotton producers very low. Although the acreage devoted to raw cotton production shrank by 15 percent in the 1990s, cotton fiber for export remains an important source of foreign currency revenues for the Government. It is still equal in value to grain production (roughly $100 million), which expanded greatly due to price increases and its greater profitability than cotton (given present circumstances). Given the 23 percent tax on cotton fiber, the cotton sub-sector is a large source of state revenue (about 25 percent of the total). This tax should be reduced to no more than 10 percent by 2005 if cotton is to become a crop that farmers freely opt to cultivate more widely. The recently completed privatization of cotton ginneries will foster an efficient, competitive cotton industry that passes on better prices for cotton to the farm-gate level. 25. Regional and national markets will not be formed if the informal barriers to marketing of agricultural products are permitted to continue on their current scale. Roadblocks impose high transactions costs through the confiscation of live animals and other agricultural products being transported. This makes it so unattractive to market products that farmers reportedly often resort to marketing livestock by following obscure mountain paths into neighboring Kyrgyzstan. Those who nmanage to overcome the roadblocks must contend with corrupt local inspectors, policemen, and criminal groups that control commerce in bazaars. 26. Another serious challenge is to assure the sustainability of the irrigation system. Main irrigation and drainage infrastructure is in danger of collapse. Water use efficiency in main and field canals is low. Newly privatized farm units lack institutional mechanisms to help them organize themselves into independent, self-financing organizations for the efficient allocation and distribution of water resources at the field level. Water and power supply for the irrigation sector is highly subsidized. Water charges introduced by the Government cover only 20 percent of required maintenance, not to speak of energy costs. The share of full operations and maintenance costs (including energy use at no less than $.025 per kwh) borne by water user tariffs should rise to at least 50 percent by 2005 if there is to be finance for the maintenance of the Executive Summary ix irrigation system. However, cost recovery must be preceded by continued farm restructuring and price liberalization so that farmers can afford water charges. Forming Water User Groups and associations at the inter-farm level is also needed to improve efficiency in operations and maintenance. 27. As outlined above, the refinement of existing reform programs and the adoption of additional measures in the near future will continue the process of restructuring agriculture for greater efficiency. First, the process of allocating land to farmers needs to be characterized by a higher degree of equity and transparency in order to avoid weakening the Government's credibility and undermining the reform program itself. Then the farming sector's terms of trade need to be improved by reducing taxation of the cotton sector, truly abolishing the cotton production quota system, and fostering the development of markets through the reduction of product confiscation at roadblocks. Next, the sustainability of the irrigation system needs to be assured through increases in water tariffs to fund system maintenance. A legal and institutional framework is also necessary for eventual marketing of property rights and consolidation as land is transferred to those who derive the highest marginal benefit from it. This will also lay the foundation for a rural finance system. With these and a number of the other policy changes mentioned in Chapter 3, the sector is capable of sustaining growth in the range of 5-7 percent per annum. Banking and Finance 28. Tajikistan's financial system is weak, and requires further development to support growth in other sectors of the economy. The initial stages of the implementation of the banking reform program launched in 1998 produced some positive results. However, the momentum could not be maintained, and the financial system is still not able to perform its resource mobilization and allocation function. At the aggregate level the nascent development of the sector and the population's lack of confidence in it are reflected in low monetization and intermediation ratios. M2/GDP currently stands at about 5 percent, the household deposit to GDP ratio was 0.2 percent in 1999, and both of these ratios are among the lowest in the FSU. Given the inability of the banks to collect deposits or attract other sources of funds, bank credit is also very low at about 10 percent of GDP. For the financial system to support economic growth, it must be able to collect more deposits and issue more credits. 29. Sector structure is still evolving, and several factors continue to undermine confidence in the banking system. At the beginning of 1998 there were 27 commercial banks. Since then a series of increases in minimum capital requirements., in addition to bankruptcy proceedings against two banks, has reduced this number to 19. Further liquidations and consolidation of the sector are expected, as there were 9 banks that did not comply with the minimum capital requirements set for the end of 1999. The policy of encouraging sectoral consolidation is likely to be beneficial, because the public will have difficulty in identifying good banks until the poorly performing banks are out of the system. The use of banks as tax collectors and the lack of confidentiality also keep the public away from the banking system. These serious problems need to be addressed in the near future. Executive Summary x 30. The stock of non-performing loans continues to be a problem. As of the end of 1999, some 45 percent of the outstanding loans of the 7 largest banks were classified as problem (5 percent) or loss (40 percent), requiring 75 and 100 percent provisioning, respectively. Agroinvestbank carries about 60 percent of the bad loans, most of which are due to directed credits, essentially subsidies to agriculture prior to 1997. Athough in some cases banks undertake measures to improve the collection of bad loans and develop credit evaluation procedures, the sector continued to generate a sizable flow of non- performning loans in 1999, which requires the attention of the authorities. 31. Bank restructuring programs produced mixed results, and a new program is about to be implemented. Bank restructuring agreements were signed in 1998 between the major banks (Agroinvestbank, Savings Bank, Tajikbankbusiness, and Vneshekonombank) and the National Bank of Tajikistan. The agreements envisioned reorganizing bank management structure, reducing employment, collecting overdue loans and increasing paid-in capital. The continuation of directed credit policies through Agroinvestbank added to the stock of non-performing of loans on that bank's balance sheet, which negatively affected its financial viability. The Savings Bank could not improve its loan collection ratio and overhead cost reduction, and it also remains underprovisioned for loan losses. Tajikbankbusiness was liquidated, which was a direct result of the restructuring agreement. By contrast, the agreement with Vneshekonombank was cancelled in 1999 following a considerable improvement in the bank's performance. Presently, the preparation of a new set of bank restructuring agreements with the four largest banks is underway to consolidate the reforrns. These agreements should be enforced consistently. 32. Several measures need to be taken to develop a viable financial system that can support businesses in all sectors of the economy. A pressing issue that must be dealt with in the short term is that of non-performing loans. Without removing the bad loans from bank balance sheets, restructuring the sector will be very difficult. The Supervision Department (BSD) of the NBT is already managing the assets of the banks closed earlier, and it is expected that the BSD will assume responsibility for more bank assets if upcoming agreements with banks progress as planned. This would distract BSD from its supervisory role. Thus, there is a need to create an Asset Management Company that will be responsible for collecting the non-performing loans of closed banks, asset sales, and debt restructuring. 33. Banks should pursue financial and operational restructuring over the medium term to deal with portfolio problems and strengthen their overall financial performance within the context of the new bank restructuring program. Bank restructuring efforts should be directed to increase the banks' capacity to lend in a prudent manner by improving the collection of already outstanding loans, as well as introducing credit evaluation and risk management techniques to avoid the accumulation of non-performing loans in the future. The exit of poorly performing banks should be an ongoing process, because the consolidation of the banking system is a necessary condition to improve confidence in the sector. A law guaranteeing such confidentiality should be drafted in the short term. Executive Summary xi 34. Covering the short and medium terms, institutional development is critical for improving performance and encouraging private entry to maintain a, reasonable degree of competition in the financial sector. This requires enforcing prudential standards and, most importantly, creating a pro-active and independent supervision agency capable of identifying problem banks and initiating bankruptcies, which should further strengthen the banking system. A number of banks are not meeting regulations such as those for reserve requirements, and this should not be permitted. Establishing a problem bank unit within the BSD will be particularly useful to identify problem banks before their losses become too large. Telecommunications 35. Tajikistan can benefit greatly from developing its telecommunications capabilities. Creating an enabling environment for private enterprise in this sector will facilitate greater contact with the outside world, improve information exchange, increase the efficiency of social service delivery, and reduce transaction costs in sectors such as finance (i.e. information processing and electronic payment and clearing systems). During the l990s the share of telecommunications services in Tajikistan's GDP remained around 0.5 percent, whereas this share is considerably larger in other developing countries. While over the last few years many countries with transition economies have experienced unprecedented growth in new communications services, Tajikistan has at most 600 cellular and 300 Internet subscribers, all in Dushanbe. 36. Tajikistan's telecommunications sector is dominated by the state. Presently, the Government controls the monopoly fixed line telecommunications operator (Tajiktelekom) and the broadcasting enterprise (Teleradio Communications), which in turn own shares in the only cellular, trunking, and paging operators. Although the telecommunications, postal, and broadcasting services have been separated, operational and regulatory functions remain closely intertwined. Tajiktelekom and Teleradio Communications carry out many regulatory functions and are heavily involved in drafting legislation. In addition to excessive government interference, non-transparent and non-competitive licensing increases investor risk and constrains entry into new services such as Internet. Lack of interconnection and revenue sharing agreements between private operators and the public monopoly distort equitable access to the public switched network and deprive operators of the revenues they generate. Private entry is limited to joint ventures with the state monopoly operator. 37. Existing infrastructure is outdated and managed inefficiently. There has been hardly any investment in the sector for the past ten years. Although Tajikistan has a relatively high teledensity (3 main fixed lines in service for every 100 inhabitants) given its level of per capita GDP, equipment is outdated (only 7 percent digitalization rate) and maintenance is inadequate. Non demand-driven allocation of lines has resulted in an inefficient network structure where lines are allocated to customers who barely use them and/or do not pay their bills, while major capacity shortages constrain new residential, business, and Government demand. Urban areas have much greater access to telecommunications than the countryside, where most of Tajikistan's population lives and works. Moreover, the present telecommunications market is largely confined to fixed Executive Summary xii telephone services. Access to new communications services through mobile networks or the Internet, as well as more modest communications facilities such as fax machines, lags well behind what might be reasonably expected given income levels. Rudimentary telecommunications infrastructure and low accessibility constrain access to markets, inhibit private sector growth, impede competition, and hinder the efficient delivery of public services such as education, health, and security. 38. Tajikistan's telecommunications sector is in a precarious financial position. The sector derives only $35 in revenue for every main line in service, one of the lowest averages in the world (well below $736 for Africa). Low local tariffs are cross-subsidized by disproportionately high international tariffs, which reduces competitiveness and disadvantages exporters. A direct consequence of state cross-ownership is that, because accounts among Government agencies and state companies are often not settled or are settled through barter, small telecommunications operators have difficulties in claiming overdue payments from SOEs to whom the Ministry of Communications is in arrears. Low revenues have starved operators of the resources needed to modernize and expand the network. 39. Several short term actions can improve the performance of the sector by facilitating the competitive entry of private entrepreneurs. First and foremost, a comprehensive sector strategy and a new law on telecommunications need to be drafted and adopted that enable the emergence of a true multi-operator structure for both service and infrastructure providers. Policymaking, regulation, and operations in the sector must be separated, while permitting and empowering an independent regulator. The Government should establish a transparent licensing regime for communications infrastructure and service providers (especially mobile and Internet) with sample licenses and competitive bidding procedures. Existing licenses require revision to assure that no exclusivity is kept and that all operators are subject to the same rights and obligations, including build-out. There is also a need to develop a regulatory framework that puts all operators on equal footing with respect to tariffs, interconnection, and universal access and frequency management. 40. Meanwhile, the government should prepare for fundamental restructuring in the medium term. The eventual introduction of private management and equity into Tajiktelekom requires transparent and enforceable laws protecting foreign investment, as well as an enabling environment and a concrete strategy to privatize telecommunications enterprises. The Government should initiate a plan for the gradual removal of price distortions, curtailment of cross subsidies, and improvement of financial management over the medium term, which would eliminate significant barriers to private sector entry and increase the amount of funds available for investment into the sector. At the same time the focus of Tajikistan's telecommunications strategy should be shifted to "communal" rather than individual access to extend communications as much as possible to the largely impoverished population, especially in rural areas. The Goverm-nent should explore the possibility of using innovative financial mechanisms (rural investment funds) to increase rural access. A plan to connect strategic customers such as universities, academia, and hospitals to a high quality data network would facilitate better development of Tajikistan's human resources. Executive Summaryxiii Transport 41. Economic growth in Tajikistan will require an efficient transport sector to facilitate the movement of goods, services, and people, especially when the remote and landlocked location of the country is considered. Like many of the sectors of the economy that it supports, transport is in decline in Tajikistan, having shrunk from 5 to 1 percent of GDP in the 1990s. The total tonnage hauled by public transport contracted by a factor of 6.4 during 1992-98, while the number of passengers declined by over 50 percent. Average daily traffic (ADT) on main arterial roads dropped from 3,750 vehicles per day in 1990 to 800 in 1995. With recent upturns in economic activity, ADT has risen to 2,250 vpd (60 percent of 1990 levels). Due to changes in the economy, demand has shifted in favor of more localized patterns of distribution, primarily for food and other goods sold in bazaars. It is likely that small private trucking operations account for the majority of local output. Nevertheless, the movement of cotton and aluminum by rail remains significant. 42. External commerce is dependent upon cooperation with Uzbekistan, through which Tajikistan's rail and road network must pass to reach world markets. While Tajik Rail has an excellent relationship with its Uzbekistan counterpart, significant barriers such as arbitrary enforcement of regulations and demand of inforrnal payments prevent Tajikistan's trucking operations from fully participating in the regional transport market. Therefore, the Multi-Lateral Agreement on free transit across borders and the development of an accompanying supervisory body within the Central Asia - Caucasus - Europe Transport Corridor (TRACECA) project sponsored by the European Union are of critical importance to Tajikistan's potential as a regional transporter. 43. The Government is in the process of reorganizing its management of the sector and a new transport law has been enacted. However, state involvement in the sector is still considerable. A new Transport Law has been enacted in the second half 2000 and a new phase of restructuring of the sector is underway. The new law brings Tajik Air and Tajik Rail under the supervision of the Ministry of Transport. However, State-owned enterprises under the Ministry of Transport comprise most of the sector, especially in passenger services. Privatization, which has occurred entirely within the trucking industry, appears to be accelerating on a somewhat ad hoc basis. Transparency and regulation should be strengthened, and the sector could provide the Government with more tax revenue. Although many vehicles have fallen out of commission due to age and poor repair, there is significant excess capacity in the road fleet and the operations it supports. Prices for public transport services are highly subsidized, especially for long distance freight and passenger transport. For example, in Dushanbe the cost of passenger service in 1998 exceeded revenues from tariffs by 300 percent. Because of lax financial discipline, the lack of autonomy from the Government, and failure to adequately account for depreciation, Tajik Rail has postponed needed maintenance and renewal. Given the country's level of income, road and rail infrastructure are extensive and of relatively good quality. However, the Government cannot fund road maintenance under existing cost Executive Summary xiv recovery arrangements (the Road Fund)-one-sixth of the estimated required amount was allocated in 1998. There appears to be significant distortions in the taxes that provide revenues for maintenance. 44. Transport is greatly limited by poor governance of internal checkpoints on roads and the nascent development of the customs service. Extortion from drivers at control posts on Tajikistan's highways often accounts for up to 50 percent of the cost of the freight haul, which is passed on to the consumer of the goods hauled in the form of higher prices. Because the customs service was created only in the last decade and still does not perform up to professional standards, significant amounts of contraband, primarily opiates, are smuggled across Tajikistan's border with Afghanistan and shipped northward to the rest of the FSU. 45. Several short and medium term actions will help the transport sector contribute to economic growth. The new Transport Law needs to be supported by a regulatory framework. Separation of operational and regulatory functions would promote competition and eliminate conflicts of interest. On a regional level, efforts should be concentrated on the implementation of the Multi-Lateral Agreement sponsored by TRACECA. The continued privatization of the road fleet should be organized in a transparent way, while Tajik Rail and Tajik Air should be corporatized. Both the Tajik Air and the Tajik Rail should be split into separate business units and should be prepared for eventual privatization, espcially the Tajik Air. Replacement of the road fleet should be kept to a minimum until excess capacity is eliminated and operations are brought in line with actual levels of demand. Reprofiling of the truck fleet can occur over a period of ten years. Because the rail fleet is in better condition than the road fleet, there is little need for new rolling stock, although a program of factory exchange of existing main line locomotives should be started to increase reliability and ensure the provision of locomotives in the future. The refinement of cost recovery and user-pay principles embodied in the Road Fund would lead to higher revenues and improved road maintenance efforts. Another financially sustainable maintenance alternative is to encourage rural communities to maintain local roads on a labor-intensive basis. Although the situation has improved considerably since the 1997 peace accord, improving governance at highway checkpoints and training and strengthening the customs service is absolutely essential for the growth of internal and external commerce. If Tajikistan's economy develops as expected and the foregoing measures are successfully implemented, transport sector output could grow by as much as 5-6 percent annually. Conclusion 46. With political stability and a reasonable degree of economic stabilization achieved, Tajikistan is now poised to implement a new phase of reforms to facilitate growth with the ultimate objective of reducing widespread poverty. Restructuring the main sectors of the economy can enable Tajikistan to make the most out of its existing physical and human capital. The reform agenda is large, and the policy measures proposed in this CEM for each sector are interrelated. Thus, they need to be implemented simultaneously and in a well sequenced manner. As reforms progress, sectoral linkages will become increasingly important. To the degree that it possesses the Executive Summary xv administrative capacity for reform, the Government should vigorously pursue restructuring in all areas to establish an economic environment to accelerate the rate of output growth. At the same time the reform of the social sectors should be designed to minimize losses in public welfare, as outlined in the Poverty Assessment. A higher volume of regional and international trade will also contribute to economic growth. In fact, the globalization process offers many opportunities to Tajikistan if its transport and telecommunications sectors are reformed and greater private sector involvement is encouraged. Furthermore, these sectors are needed to develop the domestic markets and support all other sectors of the economy. The analysis presented in this report demonstrates that the potential gains from a well sequenced and coordinated reform program could be on the order of an additional 5 percent in real GDP growth over the next 4-5 years. This would allow for much more rapid progress in improving living standards and reducing poverty. CHAPTER 1 MACROECONOMIC OVERVIEW AND GROWTH STRATEGY Introduction 1. The transition process has brought unprecedented challenges to Tajikistan. The country gained independence as one of the poorest in the former Soviet Union (FSU) and immediately faced the loss of transfers from the center, which amounted to as much as 40 percent of GDP in the late 1980s. More importantly, the eruption of the civil conflict in 1992, which continued with some interruptions until 1997, paralyzed the reform process. As a result, the achievement of price stability and implementation of structural reforms were delayed until 1997. In addition, Tajikistan was hit by a number of natural disasters, including floods, mudslides, and avalanches. The combined effect of these developments and the break-up of the FSU has been a severe contraction in measured (GDP between 1991 and 1997 of about 60 percent on a cumulative basis. 2. The signing of a peace agreement between the Government and the United Tajik Opposition in mid-1997 established a basis for normalizing the situation. The process of national reconciliation enabled the Government to focus on a reform program, which was originally developed in 1996 with the assistance of the IMF and World Bank. The authorities were successful in controlling inflation, and reform efforts were renewed, with reasonably significant achievements to date. Small scale privatization was completed in 1999, and large scale enterprise reforms were initiated. Progress was made in the agricultural sector-by 2000, usage rights to almost half of the arable land had been transferred to private farmers. Financial sector restructuring began in 1998, and the initial stages of the process have produced some positive results. As a result of this package of reforms and a more stable political environment, GDP started to grow in 1997. Between 1997 and 2000, the cumulative growth rate was almost 20 percent. 3. While these are positive developments, the country is facing many challenges, the most important being the reduction of poverty. The World Bank's recent Poverty Assessment Report (PA) shows that the severe contraction of output between 1991 and 1997 was associated with a rapid rise in poverty. According to various estimates, 60-80 percent of the population now live in poverty. With an estimated per capita GNP of about $290, Tajikistan is the poorest country in the former Soviet Union (FSU). Thus, it is critical to sustain and accelerate economic growth to reduce poverty-the goal of this Country Economic Memorandum (CEM) is to help the Government develop a set of policies to achieve this objective. For this reason, the report focuses on productive economic sectors such as industry and agriculture. Key service sectors, such as finance and banking, and telecommunications and transport are also reviewed due to their importance for the expansion of domestic economic activity and regional and international trade. Since the social sectors are covered under the PA they are not reviewed in this CEM. Chapter 1: Macroeconomic Overview and Growvth Strategy 2 MACROECONOMIC OVERVIEW Output Performance 4. After more than halving in the first part of 1990s, GDP contracted at a much- reduced single digit rate in 1996. In that year the Government embarked on its first comprehensive economic reform program, taking advantage of the UN-monitored cease- fire. However, initial attempts at macroeconomic stabilization were derailed in late 1996 by the resumption of hostilities, which led to a return to expansionary macroeconomic policies. The 1997 peace accord and the establishment of a relative degree of political order allowed the authorities to again focus on economic reform. Buoyed by the stabilizing effect of a peace deal and renewed reform efforts, GDP growth tumed positive in the second half of 1997, leading to an annual increase of 1.7 percent. GDP growth accelerated further in 1998 until the Russian crisis caused a sharp slowdown of the economy late in the year. 5. Despite this economic downturn, GDP grew by a strong 5.3 percent in 1998. The effects of the Russian crisis, which were transmitted through trade, intemational transfers, and the banking system, constrained growth in Tajikistan in 1999. In January-September of 1999 GDP increased by less than 1 percent on the corresponding period of 1998. Higher growth rates resumed only at the end of 1999, due to the low base effect and an 1992 1993 1994 1995 1996 1997| 1998 1999 2000 4 G.DP growth (%) -29 -16.3 -21.3 -12.4 -16.7 1.7| 5.3 3.7 8.3 CPI inflation (%, end period) 1363.8 7343.7 1.1 2131.9 40.5 163.6 3.2 30.1 60.6 -Gonsolidated budget (% of GDP)' Revenues 35.2 37.3 56 17.5 13.1 13.7 1 2 13.5 13.6 Cash balance -30.5 -23.4 -5.4 -11.9 -5.8 -3.3 -3 8 -3.1 -0.6 Foreign trade and balance of payments Merchandise exports (mn. $) 185 456 559 779 770 746 586 666 792 Merchandise imports (mn. S) 240 639 686 838 786 809 725 693 839 Current account balance (% of GDP) -18 -30.7 -20.5 -14.6 -6.8 -5.2 -9.3 -3.4 -6.4 External public debt (mn. S) 219 510 731 771 829 803 909 840 725 Gross reserves (mn. S) .. 2 1 4 14 30 65 58 87 Exchange rate (Tajik rubles/$, end period) Official 415 1,247 3,550 288 334 747 977 1436 2200 Real exchange rate (% change)3 .. 1930 -64 156 17 9 18 -9 Monetary statistics Annual average broad money 30.2 38.9 63.8 11.7 6.4 7.2 5.6 6.6 6.5 (% of GDP)' Monetary base growth (%) 678.6 1483.9 115.9 318.5 139.6 193.5 13.1 20.0 45.4 Average domestic broad money 2 3.1 4.4 19.2 20.3 19.8 211 22.4 22.3 velocity Duc to the differential value of cash and non-cash rubles prior to the introduction of the Tajik ruble in May 1995, fiscal and monetary ratios before and after the date may not be strictly comparable. 3Russian rubles before 1995 ' Versus US dollar with increase meaning appreciation ' Estimate Source: State Statistical Agency, Ministry of Finance, IMF, and World Bank staff calculations Chapter 1: Macroeconomic Overview and Growth Strategy 3 improvement in world market prices of aluminum. GDP rose by 3.7 percent in 1999. Despite a drought GDP growth accelerated to 8.3 percent in 2000 on the back of a strong supply response to favorable prices for key exports - aluminum. Overall, Government reform efforts conducted in consultation with international financial institutions led to the expansion of Tajikistan's economy by around 20 percent since mid-1997. GDP Per Capita 6. Despite real GDP increases in the past 4 years, Tajikistan's economic performance should be further improved to achieve a higher standard of living for the population. Even with a real overall GDP growth rate of 5 percent, it would require 15 years for Tajikistan to reach pre-independence levels of GDP. Moreover, population growth, as in the rest of Central Asia, is rapid. Although demographic increase slowed in the 1990s 2< . . ~~~~~~~due to emigration and economic 199 1995 199 1998 199 2000' hardship, it remained Real GDP growth(%) -12. -16. 1. 5.3 3.7 8.3 in the range of 1.5 to nnual population growth (%) 2. 1.6 1 18 1. 1.6 2 percent during the latter half of the RealGDPpercapitagrowth(%) -15.1 -18.31 0. 35 2.1 67 ___Estimate __I__I___I decade. As a result, Source: State Statistical Agency and World Bank calculations real GE)P growth in per capita terms during the period was well below the overall GDP growth. In order that demographic increase does not cancel out the benefit that would otherwise accrue to the population as a result of climbing output levels, high overall GDP growth must be achieved like in 2000. Savings and Investment 7. Serious deficiencies in Tajikistan's national accounts statistics' hamper an empirical analysis of trends in the income and expenditure components of GDP. The available information indicates that, despite falling levels of fixed investment for most of the 1990s, domestic savings failed to cover even this minimal investment level, leading to persistent current account deficits that made Tajikistan a net international debtor. By 1998 fixed investment declined to an estimated 7 percent of GDP before picking up slightly in 1999, mainly on account of a substantial increase in public investmnent.2 8. As a result of the curtailment of resource transfers from Moscow and political and macroeconomic instability in the early years after independence, savings effectively collapsed. Persistent government budget deficits, at times exceeding one-third of GDP, could not possibly be compensated for by net private savings. While public dissavings have been cut since the Tajik authorities embarked on reform programs in 1996, private ' Tajikistan never prepared a full set of annual national accounts that include income generation and distribution, capital accumulation and consumption, and intemational transactions accounts. Since 1997 even a basic breakdown of GDP by income and expenditure is not available, because, according to the admission by the head of 'rajikistan's State Statistical Agency, the retirement of a key statistician effectively paralyzed the work on national accounts. 2 A large portion of this increase was for the construction of a railroad linking two important towns in the south of the country Chapter 1: Macroeconomic Overview and Growth Strategy 4 savings have not picked up sufficiently. In the Tajikistan Living Standards Survey carried out in 1999 only a quarter of households confirmed having any savings, and the average size of the savings (around 60 dollars per household3) was quite low. The Government's focus should be encouraging private savings and investment, which are the most efficient engine of economic growth. Sectoral Structure of GDP 9. Since 1995, there have been major shifts in the sectoral Figure 1.1 Sectoral Composition of Value Added composition of GDP. After declining significantly since the mid-1990s the shares of value 9D% _ added in both industry and 80% agriculture have stabilized at 7D% around 20 percent of GDP (as _ i shown in Figure 1.1). ,0% _ Simultaneously, the contribution 40% of services to the national output 30%- rose from 22 to 51 percent 20% between 1995 and 1999. 50% 10. Shifts in the structure of 1995 1996 1997 1998 1999 the GDP have been ENe:indirectaSus Services DConstruction *Agriculturesd foret.ry * ndustry accompanied by varying trends Source: State Statistical Agency in sectoral productivity. While many industrial enterprises have undergone a major adjustment, laying off employees and reducing payrolls by half since the early 1990s, agriculture has absorbed redundant industrial labor and other new entrants into the labor market. By 1998 agriculture employment was at 133 percent of 1991 levels, while gross agricultural output had fallen by over 50 percent. The rapid increase in agricultural employment led to a dramatic decline in agricultural productivity (35.5 percent of 1991 levels by 1998). With industry contributing more to GDP than agriculture using one-tenth of agriculture's labor, the gap between productivity in the two sectors is striking. The net result is that agricultural incomes are below even the economy-wide wages of $10-15 per month.4 Productivity issues are analyzed greater detail in the second half of the chapter. Foreign Trade 11. Tajikistan has a very open economy, with merchandise exports equivalent to 63 percent of GDP in 1999. Despite an increase in import tariffs in early 1999 following Tajikistan's inclusion into the Customs Union with Russia, Kazakhstan, Kyrgyzstan, and 3The figure of 60 dollars refers to accumulated savings (stock) rather than the amount saved over a certain period of time (flow). 4 The low monetary incomes in rural areas are likely to be partially offset by wide-spread subsistence farming but even combined rural incomes are still below those in urban centers as the World Bank-commissioned household survey in 1999 demonstrated. Chapter 1: Macroeconomic Overview and Growth Strategy 5 Belarus, the country's foreign trade regime remains fairly liberal, at least in terms of quantitative restrictions or non-tariff barriers. 12. The emphasis placed during the Soviet era on extreme Table 1.3 Terms of Trade, 1995-199L specialization in cotton and 1995 1996 1997 t998 1999 aluminum production to serve Indices (1995=100) processing industries in Russia Export Prices has only shifted inasmuch as Aluminum 100 82 82 74 81 these products are now exported Cotton Fiber 100 86 88 73 57 outside the FSU. Therefore, the Import Prices foreign trade structure that has Alumina 100 113 105 96 87 evolved over the ten years of Natural Gas 100 76 66 64 58 transition renders the country Petroleum Products 100 96 94 96 82 highly dependent on conditions Grain and Flour 100 228 189 129 120 highly dependent on conditions Machines and Equipment 100 96 91 87 88 in the world commodity marts Composite Indices for its main exports and imports. Export Price less electricity 100 84 85 73 75 The concentration of two-thirds Import Price less electricity 100 104 96 91 86 of Tajikistan's exports in two T commodities-aluminum and ITerms of Trade Aluminum/Alumina 100 72 78 77 94 cotton fiber-has led to Total Weighted, less electricity 100 80 88 81 87 substantial fluctuations in foreign exchange earnings from Source: World Bank staff calculations. year to year because of changes in the world prices of these commodities. 13. Export and import price fluctuations have occasionally offset each other. A decline of 9 percent in the aluminum export price in 1998 was almost matched by an 8 percent decline in prices of alumina, an input for aluminum production. A 22 percent decline in cotton fiber export price in 1999 was more than offset (on a commodity-weighted basis) by a 10 percent increase in aluminum prices. As indicated in the Table 1.3 above, Tajikistan's weighted terms of trade fluctuated during 1995-1999, but within relatively narrow bounds.5 Yet even these limited fluctuations have posed major problems for Tajikistan's producers and policymakers. A more profound shock cou.ld seriously jeopardize economic growth. In view of this, the country's commodity-exporting enterprises may benefit from commodity price hedging and risk management to dampen foreign trade shocks in the future. 14. Tajikistan has run trade and current account deficits financed through external borrowing and arrears accumulation since the early years of independence. The trade deficits in effect replaced the subsidies the republic received as a part of the Soviet Union. The rising debt problem required a reduction of deficits by cutting non-essential imports and increasing export earnings. Despite the introduction of flexible exchange rate 5Electricity has been excluded from the terms of trade index, despite its large size (it accounted for between 15 and 25 percent of merchandise exports/imports since 1995), because it is traded exclusively on an offset basis, and exports and imports have been roughly equal in size in the recent years. Chapter 1: Macroeconomic Overview and Growth Strategy 6 policies in 1996 that adjusted in line with inflation, current account deficits remained high at about 9.3 percent in 1998. Following the Russian crisis and real devaluation of the Tajik ruble, the country's foreign trade deficit declined. In 1999 the current account deficit was reduced to 3.4 percent of GDP as a result of import compression, before expanding again in 2000 to more than 6 percent of GDP as imports of food and seed for 2001 sowing necessitated by the drought was increased. The current account position could be a potential source of vulnerability and continued close monitoring and policy response by the Government will be important. Monetary Policy and Price Developments 15. The implementation of monetary policy has been uneven since the start of economic reforms in early 1996, making the achievement of price stability more difficult. Periods of monetary tightening have been interrupted by civil strife and exogenous shocks, necessitating short term reversions to inflationary budget financing and allocation of directed credits to state enterprises and farmers. 16. The original push to halt inflation in the first half of 1996 was fairly successful, with consumer prices actually falling during the second and third quarters of the year. However, stabilization was forced off track late in 1996, because the governnent had to cover a sizable budget deficit in the last quarter of the year (created by renewed civil conflict and decreasing tax collection). Deteriorating tax collections necessitated a further expansion of the National Bank's credit to the Government to cover the shortfall in revenue. Following the peace agreement in mid-1997, monetary policies were tightened again, and inflation, after peaking in August-October, subsided. Yet for the whole of 1997 CPI inflation (163.6 percent) was 4 times higher than in 1996. 17. During the first 8 months of 1998 prices and the exchange rate stabilized, although the National Bank of Figure 1.2 CPI Inflation and Exchange Rate, Tajikistan occasionally 1996-2000 provided limited directed 30 1600 credit to the economy. 25 . 40 However, the credits were promptly sterilized through 20 1 || / ~ -1200 interventions in the foreign 15 exchange market without 10 1000 11 f - - lo having a significant effect on % s H h .SooX prices. While that put o R L l w international reserves of the 0~~~~~~~~~~~~~~~~~0 00 National Bank under some Os'. 5 Iq 400 pressure, prices remained -lo stable, even falling slightly -15 = + 200 due to seasonal factors. Yet -20 - o even during this stabilization period, when public Source: State Statistical Agency and World Bank staff calculations. confidence in the national currency grew, the share of broad money in GDP did not Chapter 1: Macroeconomic Overview and Growth Strategy 7 rise above 7 percent, revealing a highly demonetized economy. The Tajik ruble's broad money velocity stood at a very high rate of around 20 at the time, indicating that (i) domestic broad money was largely limited to performing the function of- a medium of exchange and (ii) the saturation of circulation with foreign monies was high.6 18. Monetary and exchange rate stability was threatened again with the onset of the Russian crisis in August of 1998. The Tajik Ruble came under pressure. After initial attempts to maintain exchange rate stability, the National Bank was forced to curtail interventions, and over the next 15 months the exchange rate steadily depreciated by more than 50 percent. Foreign exchange reserves nevertheless declined from a high of $65 million at the end of 1998 to $40 million at the end of the third quarter of 1999. They did not recover to pre-crisis levels until March of 2000. The National Bank also had to increase directed lending to the government in late 1998 to fill the budget financing gap and again the next year to take the place of a foreign commercial bank syndicate in lending to cotton producers. The resulting money supply growth led to a resurgence of inflation in April and late summer of 1999, peaking in August at 16 percent. December- to-December inflation in 1999 was 30.1 percent. However, inflationary expectations could not be fully eliminated, as the quarterly money supply growth accelerated again to double digits at the end of 1999 and exchange rate depreciation continued.7 i October 2000 Tajikistan carried a monetary reform by replacing Tajik rubles, which were in circulation since May 1995, with a new national currency - somoni. Inflation re-emerged around the time of the somoni introduction, in part caused by a temporary depreciation that occurred soon after this monetary reform. During September-November 2000 consumer prices rose cumulatively by around 30 percent, and in 2000 as a whole CPI inflation exceeded 60 percent. An important task before the authorities is letting the National Bank of Tajikistan (NBT) build its credibility through an independent monetary policy designed to create a stable environment for the operation of businesses, rather than assigning to NBT the functions of a commercial bank to provide financing to enterprises. Directed credits should be phased out as the banking sector is strengthened, and monetary policy should be tightened. This is necessary not only for price stability, but also for supporting hard budget constraints and the resource allocation process. Fiscal Management 19. Tajikistan's fiscal system has undergone significant transformation since 1995. Among the first measures of the Government's 1996 reform package were consolidation of fiscal management, overhaul of the tax system, government expenditures, and a switch to non-inflationary means of financing the budget deficit. The govermnent replaced high marginal taxes on cotton and aluminum8 with lower presumptive taxes (later replacing them with sales taxes), eliminated extrabudgetary claims on cotton and aluminum export earnings, cancelled wasteful grain subsidies (which amounted to 14 percent of GDP in the fourth quarter of 1995) with a targeted cash compensation scheme, and reduced water 6 Tajikistan is one of the few transition economies where, in addition to the US dollar, the Russian nible is extensively used and effectively is convertible. 7 An IMF study of inflation in Tajikistan suggests that substantial lags exist between a shock-like money supply expansion or exchange rate depreciation and price level changes. For example, it is estimated that it may take up to 8 months for an effect of an exchange rate devaluation to translate entirely into higher inflation. 8 They sometimes reached 80 percent. Chapter 1: Macroeconomic Overview and Growth Strategy 8 and electricity subsidies. Government expenditures dropped from 27 percent of GDP in 1995 to 18 percent of GDP in 1996, while revenue declines were more modest. This allowed the Government to reduce the cash budget deficit in 1996 from over 10 to 5.8 percent of GDP. By financing two-thirds of the remaining deficit, international financial organizations assisted the Govermment in its reform program. 20. Floods in the spring of Figure 1.3 Fiscal Position of the Government, 1996 (which necessitated 1995-1999 emergency lending to replant 20 crops) and a resumption of 17.5 civil strife in the last quarter of is 1 3 the year caused a compression 131 13. 12. 13. of revenues and forced the 10 government to increase s- _ unbudgeted expenditures. This O - undermined fiscal austerity O and led to a rise in the budget -s- 3 -3.1 deficit during the fourth n -58 quarter of 1996 and first half -to i Cashubudgetdeidticia of 1997. The deficit reached -19Budget venu 10 percent of GDP, much of it 1995 1996 1997 1998 1999 covered by the Central Bank, thereby igniting inflation. Source: Ministry of Finance and IMF Large budget arrears on the order of 3 percent of GDP were also accumulated. 21. In late 1997 the government successfully contained the fiscal expansion of the first half of the year, bringing the budget deficit to under 4 percent and keeping it below that level since then. The government has also made a progress in moving tax incidence from production to consumption taxes. The next year the government reduced sales taxes on cotton and aluminum, which accounted for more than one-third of total budget revenues.9 Combined with a decline in aluminum and cotton fiber prices, this led to a fall in total revenue from the sales tax on these commodities, which in 1999 was compensated through better administration and collection of personal income, property, and payroll taxes, as well as grants from abroad. In 2000 budget performnance improved somewhat with consolidated budget deficit outcome for the year as a whole at 0.6 percent of GDP, lower than envisioned under the IMF program. Yet the Government of Tajikistan has limited resources to provide basic public services for the population, let alone carry out public investment to prevent the decay of the extensive infrastructure inherited from the Soviet era.10 Furthermore, interest due has been high over the past 4 years, even though Tajikistan paid only a portion of it (close to 1 percent of GDP) and accumulated arrears. External debt service will rise even more in 2001-02 as grace periods on previously rescheduled bilateral debt expire. Without external financing through debt relief, new 9 From 25 to 23 percent for cotton and from 5 to 4 percent for aluminum. 1' Tajikistan's consolidated government revenue to GDP ratio is lower than any other FSU country except Georgia. Chapter 1: Macroeconomic Overview and Growth Strategy 9 grants, and/or other highly concessional lending, Tajikistan is unlikely to escape the low income-high debt trap. External Debt 22. Upon the dissolution of the Soviet Union, the Tajik authorities attempted to maintain the general trade pattern formed under central planning. Until late 1995, when Tajikistan embarked on comprehensive economic reform, the Government maintained trade relations with most former Soviet republics on the basis of annual intergovernmental trade agreements that covered most of the country's exports and imports (especially commodities such as cotton, aluminum, grain, natural gas and oil). Under the agreements, the Governmnent guaranteed import payments by state Figure 1.4 Extemal Public and Publicly Guaranteed enterporise payend y ectivel Debt and Debt Service Due, 1992-2004 enterpnlses and effectively 1,0 20 acquired the responsibility of 1,200 I Externalpublic debt (mn. S - left scale) financing the foreign trade -- Extrnal public debt service due (mn. S - righ scale)s deficit from the center. As a 1,000 160 result, despite Tajikistan / 140 signing a "zero option" 8 agreement with Russia in a X October 19931 1, its public debt 60 exploded, rising to over 0.7 so billion dollars by 1996. Credit 400 6 from Tajikistan's main trading 40 partners, Russia and 200 20 Uzbekistan, accounted for the bulk of the debt. The European o o Union, Turkey, and the United 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 States also provided Source: Ministry of Finance and World Bank/IMF staff projections. commodity credits during the period. 23. However, as intra-FSU trading credits and the European Union loan were at short maturities (3-5 years), debt service arrears accumulated rapidly. With over a quarter of debt in arrears by end-1995, external financing dried up. After trying a piecemeal approach that entailed agreeing on repayment deferments on debt to Russia and Uzbekistan during 1994-95, Tajikistan, with the guidance of international financial institutions, pursued a more unified strategy. Following a number of round-table consultations with key donors in 1995-96, which delineated approaches to debt rescheduling' 2, deals were concluded with bilateral creditors. 24. Debt rose again in 1998 to over $0.9 billion, as a consortium of international commercial banks provided forward financing to cotton producers and interest arrears " Under the agreement, Russia assumed all the liabilities of the USSR in return for other former Soviet republics agreeing not to lay claims against the USSR's foreign assets. 12 Terms of rescheduling broadly agreed during the consultations included a maturity of 15 years, a grace period of 5 years, and a concessional interest rate. Chapter 1: Macroeconomic Overview and Growth Strategy 10 and penalties on overdue debt were incorporated into principal under the debt rescheduling deals. However, terms on some of the deals were worse than the agreed guidelines. In January of 1997 debt rescheduling of $204 million owed to Uzbekistan provided for a repayment period of 5 years, which soon proved burdensome. 25. By the end of 1999 Tajikistan's total external public and publicly guaranteed debt reached declined slightly to little under $0.9 bn, or 77% of GDP. Due to a high share of bilateral debt rescheduled on concessionary terms and long-term loans from international financial organizations, the debt has a sizable grant element.)3 According to Heavily Indebted Poor Countries Initiative (HIPC) criteria that use present value of debt to determine eligibility for debt relief, Tajikistan can be classified an impoverished country with an unsustainably high debt. The burden of debt on public finances is particularly heavy, with the present value of debt to consolidated government revenues close to 400 percent at the end of 1999, far above the Modified HIPC threshold of 250 percent. 26. About one-fourth of outstanding external debt (at face value) at the end of 1999 was owed to intemational financial organizations, and close to 50 percent was accounted for by official bilateral donors, of which Russia and Uzbekistan remained the largest, with $162 million and $143 million in debt owed, respectively. A significant portion of the debt is not formally publicly guaranteed (in particular, around $150 million of arrears on suppliers' credits by the state-owned TADAZ aluminum smelter). However, given the significance of the enterprise to the Tajik economy, it is effectively a contingent liability of the Government. 27. Debt service is also expected to increase in the coming years, to $70-80 million per annum as the grace periods on previously rescheduled debt expire over the next 3 years. By most measures, it will strain the capacity of the Governmnent of Tajikistan to pay. This makes another round of debt reschedulings on concessionary terms an important item of Tajikistan's development agenda. The sustainability of external debt and its implications for growth and social expenditures are further discussed in chapter 7. Medium Term Expenditure Program and Public Investment Program 28. Because the Government's expenditure and revenue policies will have a significant impact on the budget over a number of years, Tajikistan should add a Medium Term Financial Framework (MTFF) to its collection of macroeconomic management tools. The MTFF should be a strategic policy and expenditure framework, fully integrated with the budget, which includes priority investment projects and simultaneously provides line ministries with greater responsibility for resource allocation decisions. If appropriately developed, an MTFF can also become an effective macroeconomic planning tool and support economic growth. 29. The MTFF could also enable the country to attract more donor funding for public investment projects. Between 1998 and 2000, Tajikistan produced Public Investment Programs (PIP), which were presented at donor conferences. However, these were not part of a well designed MTFF and were inadequately developed. Owing to the political 13 Present value of Tajikistan's debt is estimated to be around 64% of its face value. Chapter 1: Macroeconomic Overview and Growth Strategy 11 situation, financing received from donors was small, and most external assistance consisted of humanitarian aid. The PIPs during 1998-2000 included 28 projects with a total cost of $414 million. Initially, only 3 projects received commitments and funds totaling $40 million, but by 1999 donor commitments rose to $137 million. However, disbursements have been slow. It is estimated that total disbursements before 2000 were about $69 million, which is almost half of the commitments. 30. Taking advantage of the improved political situation, the Government developed a draft PIP covering the period 2000-02. The draft indicates that commitments received from external donors to date for 2000-02 are about $280 million. For the year 2000 alone, the committed amount is $137 million, which represents 12 percent of GDP. However, as shown in Table 1.4 below, the portion of disbursements for which full funding is assured is small. While it is indicated in the draft PIP that many projects are at an advanced stage and there is a good chance that they will be fully funded, there is also reason to be cautious. Disbursements will probably depend upon the progress of reforms, Table 1A Projected External Financing Comni-tments, 200002 ($million) __ _______ Commitments 2000 2001 2002 Total Funded Projects 19.2 - - 19.2 Funding Under 118.3 102.0 60.0 280.3 Discussion Financing Needed - 10.0 50.0 60.0 TOTAL 137.5 _ 112.0 _ 110.0 359.5. Source: Draft Government of Tajikistan Public Investment Program 2000. and the Government should take into account the fact that actual resource flows are usually slower than expected. 31. The size of public investment and its possible financing also has significant implications for the required contribution from the budget for counterpart funds. In fact, the capacity of the budget to accommodate public investments funded by donors is likely to be constrained by possible shortages of counterpart funds. A number of World Bank projects are currently facing difficulties owing to the lack of counterpart funds, an issue that requires the urgent attention of the Government. MEDIUM TERM GROWTH STRATEGY Productivity and Economic Growth in Tajikistan Productivity, Poverty, and Growth 32. While the level of investment may be higher as donors may fund more projects, raising economy-wide productivity is still the key to sustaining growth and reducing poverty. The contribution of investment to growth depends on its productivity. Presently, productivity across sectors is very low, which means that Tajikistan has not Chapter 1: Macroeconomic Overview and Growth Strategy 12 derived the full potential benefit of its physical and human capital. There is also evidence that the reallocation of resources that occurred during 1992-98 was not always in the right direction, which reduced productivity. For example, the large movement of labor into agriculture sharply lowered productivity in that sector, which had the effect of lowering wages and rural incomes. Therefore, raising labor productivity is the main avenue to increasing output and reducing poverty. If a strong policy framework is in place, a medium term strategy based on raising productivity is also likely to generate more investment to sustain growth over the longer term. The Importance of Productivity and Productivity Trends 33. A recent study by De Broeck and Koen (2000) computed TFP growth rates for all FSU countries through 1997 using the growth accounting framework described below. In this report, the analysis is extended until 1998 with some minor adjustments.'4 The results must be qualified, because measured output declines were the result of major ttrtidn rot acunig rmeok tha ebhsbes ai i iX~~~~~~~n aof p an 4Glthei c btin to0 grwth ithitisX fawok,gr t)iils 0idXepos Spto eemnt Xhr 14s cpilta iaswesmet,and. is labo . ~, . Oi i i V iE..d"jgS |gg , ,,,,,,i},0 l ;1 ~~~~~~~~~~~~~~~~~~I A A~yen) wihierp~iv brs r is N esr fpo~i~~ . hi~ r1 .tiom. Output Capital Labor Factor TFP Labor W'ei p~~4a~~ivi~~yGrowth Gowt GT i rowth~ Conriabutio GrowthPri~~eodu tivity ,e t i .'1 991 -7.f1 l t.9 l1.7 l1.7 -8.8 -7.3FPi*iinber: . .1992 -29 0.6 -3.2 -2 -27 -21.~6 }0 . 1993 | I 0 6 -2.8S -I .8 -9 .2 1I6 .4 .. . i1994 -18.9 l1 -0.6 -0.7 -18.2 11 9 , ,1995 -12.5 -I1.3 0.5 -0. l -l12.4 -I 0.9 .i,£ix1996 -4.4 -I1.7 -6.5 -0.7 -3.7 -I l. 1 0 ti 0 0 i i i £ i 1997 l1.7 -l .4 3.3 l1.9 -0.2 -21.6 0i S SS