Report No. 31014-UZ Republic of Uzbekistan Public Expenditure Review March 1, 2005 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank TABLE CONTENTSOF EXECUTIVE SUMMARY ........................................................................................................... i GENERALGOVERNMENTFISCAL OPERATIONS............................................................................. i HEALTH ........................................................................................................................................ 11 EDUCATION ................................................................................................................................. 111 PUBLIC EXPENDITURE MANAGEMENT ......................................................................................... V CHAPTER 1 GENERALGOVERNMENT FISCALOPERATIONS AND ROLE OF . THE STATE ......................................................................................................... 1 A. INTRODUCTION ....................................................................................................................... 1 B STRUCTUREAND SIZEOF GOVERNMENT c.. FISCALAND QUASIFISCAL OPERATIONS ...............1 DECLININGBUDGET RESOURCE ENVELOPE TAXPOLICY ISSUES 4 AND .................................. D. TRENDSINGOVERNMENT E. ECONOMIC EXPENDITURES ............................................................................. 7 COMPOSITION OF CONSOLIDATED BUDGET EXPENDITURES ............................... 9 F. REDUCTIONINQUASI-FISCALOPERATIONS ......................................................................... 12 G FISCALADJUSTMENT AND SOURCES OFBUDGET 12 H CHANGINGTHEROLEOFTHE STATEINUZBEKISTAN.......................................................... .. FINANCING............................................. 14 CHAPTER 2 HEALTH . ............................................................................................................ 16 A. INTRODUCTION ..................................................................................................................... 16 B GOVERNMENT . REFORMS ...................................................................................................... 16 c. KEYISSUESAND D. RECOMMENDATIONS AND OPTIONS FORREFININGHEALTH CHALLENGES ............................................................................................ 18 POLICY AND IMPROVING THE EFFICIENCYAND EQUITY OFEXPENDITURES ............................................................................ 24 0.1 Short-Term (Within 1 Year) ........................................................................................... 24 0 . 2 Medium-Term (1-3 Years).............................................................................................. 25 0 . 3 Longer-Term (3-5 Years) ............................................................................................... 28 CHAPTER3 EDUCATION . ..................................................................................................... 29 A. INTRODUCTION ..................................................................................................................... 29 B. CHALLENGES........................................................................................................................ 29 C. GOVERNMENT POLICY RESPONSE ........................................................................................ 30 C.1. Changes in Financing of Education.............................................................................. 30 D.C.2. Changes in the Structure of Education.......................................................................... 31 EDUCATION EXPENDITURES ................................................................................................. 32 D.1. PrivateExpendituresfor Education.............................................................................. 32 0.2. Public Expenditures on Education ......................................................................... 33 E. MANAGEMENTFINANCINGOFEDAND TION ................................................................. 36 F RECOMMENDATIONS OPTIONSFORREFININGEDUCATION . AND POLICY ............................ 37 F.1. Improving theEfficiency and Equity of Education Expenditures.................................. 37 F.2. Refining the NPPT Strategy....................................... F.3 Addressing the Needs of Basic Education .................. ............................ 41 F.4. DevelopingHigher Education......................................................... F.5.Improving Economic Outcomes .................................................................. 42 CHAPTER4 PUBLICEXPENDITURE MANAGEMENT . ................................................. 44 A. INTRODUCTION B. INSTITUTIONALARRANGEMENTS BUDGET ..................................................................................................................... 44 FOR FORMULATION .......................................... 44 B.1. Institutional Arrangements ............................................................... 44 B.2. Legal Framework .............. ................................................................................ 45 C. THEBUDGET PROCESS .......................................................................................................... 46 C.1. Current Budget ........................ C.2. Investment Budget C.3. Budget Classijkat ....................................................................... 48 C.4. Transparency and ....................................................... 49 C.5. Budget Execution Arrangements ................................................................................... 49 D.CIMPACTAND EXAMPLES SYSTEMDYSFLTNCTIONS .6. Budget Fragmentation................................................................................................... 50 OF .......................................................... 51 E. RECENT AND PROPOSEDREFORMS ....................................................................................... 51 E.1. Budget Preparation ....................................................................................................... 52 E.2. Medium Term Budgetary Perspective (MTBP) ............................................................. 53 F.E.3. Budget Execution - TheImplications of TheIntroduction of a Treasury System ..........53 MAINRECOMMENDATIONS ................................................................................................... 55 F.1. Short Term (within oneyear)...................................................................... F.2. Medium Term (one to threeyears) . .................................................................. 56 G CONCLUSION .F.3. Long Term (over threeyears) ........................................................................................ 57 ........................................................................................................................ 58 Tables Table 1.1. Consolidated BudgetExpenditures. 1995-2003.............................................................. 3 Table 1.2. Consolidated Budget Revenues. 1995-2003 ................................................................... 5 Table 1.3. Uzbekistan: Dynamics o f Key Tax Rates. 1998-2004................................................... 6 Table 1.4. Consolidated Budget Expenditure. 2000-2003 (economic classification. including extrabudgetary funds; percent o f GDP) ........................................................................ 9 Table 1.5. Efficiency o f Capital Investment by Sector. 1996-2003 ............................................... 11 Table 2.1. Health Spending in Selected Countries......................................................................... 20 Table 3.1, Public Expenditure on Education compared with OECD............................................. 33 Table 3.2. Public Expenditures on Education. 1995-2003............................................................. 33 Table 3.3. Per-Student Budget Costs o f Educationby Level. 2002............................................... 34 Table 3.4. Student/Teacher Ratiosby Level o f Education............................................................. 34 Table 4.1. State Budget Expenditure. 2004 ................................................................................... 47 Figures Figure 1.1.Fiscal and Quasi-fiscal Operations o f the General Government ................................... 4 Figure 1.2. Consolidated Budget. including Extrabudgetary Funds. 1995-2003 ............................. 7 Figure 1.3. Government Expenditures and Per Capita Incomes inL o w and Middle-Income Countries ....................................................................................................................... 8 Figure 1.4. Main Sectoral Expenditures o f the Consolidated Budget, 1995-2003........................... 8 Figure 1.5. Select Quasifiscal Activities, 2001-2003 ..................................................................... 12 Figure 1.6. Narrow and Broad Government Deficits, 1996-2003.................................................. 13 Figure 1.7. Government and Government-Guaranteed Debt and Debt Service, 1995-2003 .........14 Figure 2.1. Public Expenditure on Health...................................................................................... 20 Figure2.2. Poorest Regions Get a Smaller Share o f Public Expenditures on Health Care ...........21 Figure 2.3. Distribution o fPublic Expenditureson In-Patient Hospital Visits, by Quintiles and UrbadRural Areas....................................................................................................... 21 Figure 2.4. Indicators of Hospital Efficiency (percentage change, 2003 to 1998)......................... 22 Figure2.5. RegionalAllocations Currently versus Per Capita with Adjusters.............................. 25 Figure3.1. Projected Growth o f School-Age Cohorts, 2000-2025................................................ 29 Boxes Box 1.1.Reorienting Fiscal Policy towards Economic Growth and Poverty Reduction: Theory and Empirical Evidence .................................................................................................... 2 Box 2.1. HealthCare ReformObjectives and Planned Actions for 1998-2005............................. 16 Box 2.2. Health Status and Trends................................................................................................. 19 Box 2.3. Challenges o f Rationalizationunder the World Bank's Health IProject Needto be Addressed........................................................................................................................ 23 Box 2.4. Seven Steps to Oblast Pooling and Per Capita Financing: An Example o f Rural Primary Health Care Budgets....................................................................................................... 24 Box 2.5. Rewarding Hospital Providers: Lessons from the Performance-BasedApproach in Transition Countries ........................................................................................................ 26 Box 2.6. Combining Autonomy, Rationalization, and Incentives: Emergent Lessons in Transition Countries ......................................................................................................................... 27 Box 3.1. The Experience o f Turkey with Vocational Education................................................... 36 Box 3.2. A Composite Formula for EducationFinance................................................................. 38 Box 3.3. Approaches to Financing Higher Education.................................................................... 43 Box 4.1. Principles o f ModernBudgeting ..................................................................................... 44 Box 4.2. K e y Areas for Improvement ofthe Budget System Law ................................................ 46 Box 4.3. Investmentinthe Education Sector: Separation o f the Investment and Current Budget 48 Box 4.4. Typical Documentation for Submission to Cabinet and Parliament ............................... 49 Box 4.5. The Main Steps Forward inthe Proposed Budget Preparation Process .......................... 52 Box 4.6. Main Treasury Functions................................................................................................. 54 ACKNOWLEDGEMENTS This first Public Expenditure Review (PER) for Uzbekistan since independence was prepared by a team including Ritu Anand (Team Leader), Andriy Storozhuk (macro-fiscal developments and role o f the state), Eskender Trushin (public investment and role o f the state), Michael Mertaugh and Dilnara Isamiddinova (education expenditure), Jack Langenbrunner, Monique Mrazek and Ilhom Maqsudov (health care expenditure), and Roland Clarke (budget processes and institutions). Doreen Duffprocessed the report very competently. Materials for the report were collected during the identification mission in June 2003 and main mission in October-November 2003. The report was discussed with the Uzbek authorities in September-October 2004. The team i s grateful to David Pearce, Martin Raiser, Helga Muller, Amp Banerji, Armin Fidler, Edmundo Murrugarra, Mukesh Chawla, Sayyora Umarova, Sevara Abdusamatova, Marco Pani, Ilona Castro and John Zohrab for information, suggestions and support. The team also appreciates the close coordination with the Country Financial Accountability Assessment team, particularly Andrew Mackie and Pascale De Lettenhove. The PER team would like to express its gratitude to the Government o f Uzbekistan, inparticular Mr. Mamarizo Nurmuratov, Minister of Finance (until July 2004), Mr. Saidahmad Rakhimov, Minister o f Finance (since July 2004), and Mr.Jamshid Kuchkarov, Deputy Minister o f Finance, for their advice and collaboration as well as for providing extensive statistical data for the report. Thanks are also due to the many staff o f the Ministry o f Finance, line Ministries and budget organizations who provided valuable information for the report and participated in discussions and seminars duringthe missions. The report was produced under the supervision o f Samuel Otoo (Sector Manager, ECSPE). The overall guidance for the report was provided by Dennis de Tray, Country Director, ECCUS, and Cheryl Gray, Department Director, ECSPE. Peer reviewers for the Report are Anand Rajaram (PRMPS), Jeni Klugman (AFTP2), and Mark Sundberg (DECVP). EXECUTIVESUMMARY This first Public Expenditure Review (PER) on Uzbekistan has been prepared as part of the World Bank's effort to establish a multiyear program o f public expenditure work with the Government o f Uzbekistan. The PER aims to show how to improve the quality o f the ongoing fiscal adjustment and increase the efficiency o f government expenditure, emphasizing the interconnections between sector policies and budgeting. At the request o f the Government, the PER focuses on the health and education sectors. The PER complements a Country Financial Accountability Assessment (CFAA), which i s beingprepared in parallel and focuses on issues o f internal control, and intemal and external audit o f public expenditures. The PER should also provide an important input to the government's strategy for improving living standards. GENERALGOVERNMENT FISCAL OPERATIONS The size o f the government in Uzbekistan has declined significantly in recent years. Chapter 1 shows that the aggregate level o f government revenue and spending has come down, extra- budgetary funds have been reduced and streamlined somewhat, and redistribution through quasi- fiscal operations has decreased (with the introduction o f convertibility and energy price increases in 2002-03). General government expenditures, including extrabudgetary funds and investment financed by "non-budgetary" government-guaranteed borrowing, have come down by over 11 percentage points o f GDP since 1998. Although substantially reduced, however, such expenditure at close to 39 percent o f GDP inUzbekistan i s still highfor a country at Uzbekistan's income level.' Moreover, the role o f the state in the Uzbek economy remains very substantial, with state planning and management control extending over much o f the enterprise sector. By focusing limited technical and financial resources on performing key state functions, Uzbekistan could increase the effectiveness o f resource management while letting the private sector lead economic growth. The reduction o f expenditure, in the face o f declining revenues, has led to a remarkable and necessary improvement inthe overall fiscal position. The broad public sector deficit has fallen to around 2 percent o f GDP by 2003 from close to 10 percent in the late 1990s and, as a result, although high, debt levels have stabilized. H o w sustainable are the deficit reductions? The expenditure cuts were across-the-board, with only education and pension spending relatively little affected. The wage bill appears to have been maintained (as a share o f GDP) as employment was protected, particularly in the health and education sectors, but the real wage has grown little, if at all. The brunt o f the reductions fell on non-salary recurrent expenditures, often vital materials and supplies, and maintenance expenditures. As a result, there are funding shortages for primary health and basic education, as Chapters 2 and 3 show, and the government i s unable to allocate sufficient expenditures on some o f its stated priorities. An important reason for such an outcome i s the budgeting system, as Chapter 4 shows, which determines budget allocations based on input norms. The Ministry of Finance (MOF) then applies cuts to the category o f "other" expenditures which often leads to a lack o f maintenance and supplies. Under-funding and inefficient expenditure allocation i s also due to other factors discussed in Chapter 4. Ensuring that key ' Consolidated budget expenditures, which exclude investment financed by "non-budgetary" govemment-guaranteed borrowing,were 35.2 percentof GDP in2003. services, such as basic health and education, are maintained and especially reach the poor, will entail a rationalization o f expenditures which, in turn, will require sectoral and associated budgeting reforms. The rest o f this report deals with the policy priorities and expenditure issues inthe health and education sectors and the necessary reforms inpublic expenditure management to implement the sector policies. HEALTH Changes in the health status o f the population are mixed and difficult to discern. While official data show an improvement in key health indicators, national level surveys raise concerns that child and maternal mortality as well as infectious diseases, such as tuberculosis, have increased and are well above the trendline necessary to meet Millennium Development Goals (MDG) targets. Against this background, the trend o f declining public expenditures on health i s o f greater concern. Public health expenditures are now 2.5 percent o f GDP or $8 per capita per year. Moreover, the allocation o fpublic health expenditures i s not optimal and shows: > per capita health spending in regions does not correlate well with health needs and poverty incidence: per capita spending i s lower in regions with a higher incidence o f > poverty expenditures skewed towards more expensive curative and in-patient facilities, which benefit the urban and richer population, and at the expense o f more cost-effective primary outpatient care (67 percent o f consolidated health expenditures go to hospitals versus 38 percent in Organization for Economic Cooperationand Development (OECD) countries) 9 disproportionately high spending on health staff salaries and benefits (60 percent), squeezing out non-staff recurrent expenditures 9 a disproportionate burdenof out-of-pocket payments for health care fall onthe poor and government-provided exemptions from paying for medical services, drugs, and equipment may not always reachthe poor. In other words, there is room for public expenditures to better address health needs and redress inequities, within the current budget constraint. A reallocation o f expenditures would be made possible if the inherited structure o f specialized in-patient care i s rationalized. Inthe last decade, numbers o f beds have been reduced, but savings can be achieved only through reductions in utilities and salaries which consume most o f the budgets. The current facility structure often reflects the inherited Soviet delivery structure which i s duplicative and outdated from a clinical standpoint. Rationalization should be accompanied with the introduction o f incentives, such as allowing any savings to be retainedby the entity (oblast and primary care facility). There should also be an increase in managerial autonomy to provide the needed flexibility and incentive to make financing and staffing decisions. Other cost containment measures could also then be taken. The consequent freeing up o f resources could then be directed towards more cost-effective outpatient care and redress the imbalance in regional and rural-urban health care delivery. Specific measures are suggested below. Short Term 0 Pool and manage health funds at the oblast level, replicating the experience in the pilot regions on primary care but possibly extended to cover all areas o f health care expenditure' * The HealthI1Projectapprovedby the World BankBoardin September 2004 has begunthis process. 11 0 Improve management o f the pharmaceuticals supply by expanding competitive bulk tenders for supply o f multi-sourceddrugs inhospitals 0 Formalize informal payments by making transparent fees or other co-payments, and launch a media campaign to inform patients o ftheir rightsto free benefits 0 Accelerate the change inthe central-to-regional allocation formula to a capitation basis as envisioned in the State Program o f Reforming Health Care S y ~ t e m .At ~ a minimum,the input-based allocation formula should be fully based on the population principle, with adjustments for patient characteristics, including demographic, epidemiological, and socio-economic factors. Further refinements could include adjustments for the cost o f delivering care inmore remote areas. Medium Term Phase inimplementationo f the adjusted per capita financing allocations to oblasts Extend the pilot per capita financing o f rural primary care facilities (SVPs) nationwide from the current five pilot regions, and begin to extend per capita financing to urban primary care practices Introduce performance-related payment mechanisms at the hospital level within an overall global budget, that rewards higher throughput while motivating a decrease in cost-per-case Incentives should be coupled with implementation o f a well-defined strategy for rationalizing health facilities (merger and closure o f hospitals) along with a staffing plan, training and incentives for health staff to move to rural areas4 Strengthen the referral system and combine it with incentives to motivate patient and provider behavior to use outpatient services more and hospital resources more sparingly Long Term 0 Expand the scope o f primary and outpatient care to treat chronic conditions routinely and some day surgeries, as i s done in OECD countries and increasingly inEastern Europe EDUCATION The Government's priority on education i s clear, as it allocates about 9 percent o f GDP on education - a higher share than any other country in the region or indeed, any OECD country. Formerly, expenditure was concentrated in the new programs o f upper secondary education, while acute funding shortages persisted in general education (grades 1-11). This imbalance in expenditures i s being addressed under the Government's major new investment program in basic education, which was adopted by Presidential decree in May, 2004. Under this program, total education expenditures are expected to rise to 11percent o f GDP. This major new initiative in basic education addresses the former budgetary neglect o f basic education. Inview o f the educational objectives o f the program, the report recommends careful monitoring o f educational outcomes including learning achievement and school attendance. To strengthen efficiency incentives, the report recommends adoption o f a capitation financing formula such as that beingpiloted under USAID financing inAkkurghan Rayon, Tashkent oblast. To address equity concerns and facilitate the move to compulsory twelve-year education, the Presidential Decree UP-2107ofNovember 1998. Presidential Decree UP-3214 of February 2003 has initiated the rationalization of types of facilities, and in 2004 a Presidential task force on provider remuneration was establishedto develop incentives for improved staffing mix. 111 ... report recommends that the Government consider additional targeted measures - such as school meals -- to overcome the constraints affecting school attendance for low-income groups. Over the medium-term, the Government could consider moving to capitation-based financing for all levels o f education. The capitation grant could also address equity issues such as intrinsic differences in costs and financial capacities between communities/rural-urban areas by financing a minimumset o f essential educational inputs. However, careful preparation is required to move to such an approach. The report also makes a number of suggestions to refine the National Program for Personnel Training (NPPT) strategy. A first best -based on international experience -would be to consider a fundamentally different approach, in which secondary education would provide a general education and be the basis for subsequent occupation-specific and job-specific training financed either by individuals or by employers (or both). However, short o f this major reorientation o f the NPPT, the report suggests a number o f ways in which concerns about cost-effectiveness, labor- market responsiveness, and equity o f the program could be addressed. Finally, regarding higher education, a two-pronged approach i s recommended: (i)allowing establishment o f private universities along with mechanisms to ensure quality, as well as (ii) usingpublic financing o fhigher educationmore selectively. In order to capture the full economic benefits of the major investments in education under the NPPT and the new program in basic education, the report recommends accelerated progress in economic reforms to promote job creation and labor mobility, including economic liberalization, enterprise privatization, capital market development, and measures to encourage direct foreign investment. Short Term Maintain the increased budget financing for basic education. Raise the ceiling for financial support for textbooks and other educational requirements for needy students, currently limited to 15 percent o f the students in each school. This proportion should vary in proportion to local needs - being greater than 15 percent in areas with widespread poverty, and less than 15 percent inareas with less poverty Increase the minimumteaching load and the base teaching salary Upgrade some o f the existing general secondary schools and extend their duration through grade 12, rather than doing this exclusively through newly constructed academic lycea. Reduce or make optional the in-enterprise portion o f the training inprofessional colleges, which will otherwise constrain full implementation o f the NPPT Improve consistency and efficiency o f education policy by merging the Ministry o f Public Education and Ministryo f Higher Education. Eliminate student stipends for students in specialized secondary education, or target them to students from the poorest families who would otherwise not be able to attend Medium Term Relax class size restrictions to give more discretion to local governments inreconfiguring schools to achieve better efficiency and better educational results Move to capitation-based financing for all levels o f education iv 0 Strengthen the academic content and reduce the vocational content inthe curricula o f the professional colleges. Consolidate the existing specializations o f the professional colleges to a small number o f broad occupational clusters with kindredskillrequirements Long Term 0 Modernize teaching and learning methods through a large-scale effort to embed the desired teaching practices in pre-service and in-service training o f teachers, and the development o f new textbooks, teachers' manuals, and other pedagogical support for the new teaching and learning methods. Provide incentives for new teaching practices through the evaluation o f schools and teachers, linked to the compensation o f teachers PUBLICEXPENDITURE MANAGEMENT Budgeting i s inseparable from policy making. Without an effective budgeting and public expenditure management system sectoral policy decisions may only be partially implemented and reforms will be slow and unsustainable. Among the consequences o f the budgeting system, which i s based upon input norms and bottom up aggregation combined with centralized reductions around economic classifications, are the following: P Resources not matching stated (sectoral) priorities o fthe government P Inadequate fundingo fsome programs (e.g. primaryhealthandbasic education) P Bias against maintenance and supplies P Short term time horizon for the allocationo fresources P Incentiveslacking to promote efficiency inresource use 9 Evaluationandaccountability madedifficult due to lack ofdata or datanotinmeaningful form for such an assessment Institutional reforms need to be initiated in order to clearly delineate responsibilities and lines o f accountability, but will take time. Principal amongst the required changes i s the strengthening o f ministries and development o f their policy making functions with associated responsibilities for budgeting. This would entail a shift o f policy development from the apparatus o f the Cabinet o f Ministers (COM) and the Presidential Administration, where sectoral units are too small to carry out effective detailed policy development and policies are developed outside o f the budgeting process, which results in inadequate funding for new initiatives or funds allocation in an ad hoc manner by the Ministryo f Finance (MOF). In addition, several improvements can be made in order to increase the comprehensiveness, transparency and accountability o f the Budget. The Budget should be formulated and approved around a fairly detailed organizational and programmatic classification rather than broad functional and economic classifications, and set in a medium term perspective. The budget, its assumptions and the overall policy guiding fiscal decisions need to be published and open to debate. This would make the institutional accountability clear as well as provide a basis for evaluating resource allocation by programs (including capital and current expenditures which should be evaluatedjointly), and assessing trade-offs and future fundingneeds. Moreover, the current program to reform the budget execution system through the establishment o f a Treasury i s fundamental to allowing effective reporting and management ofresources. It will reduce the costs o f budget management (through effective cash planning) and re-establish the confidence o f institutions that they will in fact receive the resources appropriated to them through the budget. The establishment o f the Treasury will require its benefits to be clearly demonstrated V to individual budget institutions and local governments which are concerned about their apparent reduction incontrol over financial flows. Specific measures and a realistic timeframe are indicatedbelow. Many o f these improvements in budget preparation, presentation, and execution are already being prepared by the Government, supported by a proposed World Bank-financedPublic Finance Management ReformProject. Short Term 0 Adopt fully the budget process developed for the 2005 budget, including particularly the anchoring o f the budget in a macroeconomic framework and the use o f expenditure ceilings for sectoral budgets 0 The budget, together with documentation on its assumptions and main lines o f policy, should be published 0 The Budget System Law should be amended to (a) establish the principle that the budget i s comprehensive; (b) to require enactment o f the budget by the Oliy Majlis; and (c) to separate the authority to spend from the release o f cash (which i s required for the introduction o f the Treasury) No new extra-budgetary funds should be created Medium Term Establish a high level committee o f the C O M responsible for overseeing the budget process and presenting strategic choices to the C O M Extra-budgetary funds should be subject to the same rules as the rest o f the budget (of preparation, review and audit) Extra-budgetary accounts (EBAs) should be limited to the payments for paid services and not be supplemented by budget surpluses Review the norms and regulations governing budget allocations with a view to allowing budget institutionsto prepare budgets on a programmatic basis Reorganize the MOF to have a macroeconomic analysis and forecasting department and to create a single budget department (divided into sectoral divisions) to take a view early on the overall resource envelope and reconcile sectoral demands Multi-year Public Investment Program (PIP) process should be reinstatedand coordinated by MOF Transparent operational rules and procedures should be developed for the Treasury control o f budget execution All extra-budgetary funds and accounts shouldbe includedinthe Treasury Long Term 0 Strengthen the role o f ministries inpolicy making and reorganize ministries into a small number o f functionally based ministries 0 Reformthe financing o f local governments vi CHAPTER 1. GENERAL GOVERNMENT FISCAL OPERATIONSAND ROLE OFTHE STATE A. INTRODUCTION 1.1 This chapter reviews government fiscal operations and shows that the size and scope o f the government in Uzbekistan has significantly reduced in recent years. The aggregate level of government revenue and spending has come down, extra-budgetary funds have been reduced and streamlined somewhat, the broader public sector deficit has also been cut, and redistribution through quasi-fiscal operations has decreased. What is important now i s for the government to increase the effectiveness o f its interventions, focusing on the efficiency aspects of resource mobilization and allocation. The chapter indicates that within the more constrained financing available, it is even more important and an opportune time to consider the appropriate role o f government, focus government activities and resources on its core functions - provision o f public goods, addressing market failures, reducing inequity and ensuring macroeconomic stability,- while providing the "space" and incentives for the private sector to develop and contribute to economic growth and employment generation. Box 1.1 reviews current theoretical thinking and empirical evidence on the role o f fiscal policy in promoting growth and poverty reduction. 1.2 The importance o f focusing public expenditures on human capital enhancement and targeted infrastructure investment which is confirmed by the international experience provides the underpinning o f the sectoral coverage o f this PER. Issues related to public investment in Uzbekistan are covered later in this chapter while government spending and management of education and health care are reviewed in Chapters 2 and 3. The report completes with an overview o f budget processes and their adequacy for channeling the authorities' spending towards the declared objectives of living standards improvement and equity. B. STRUCTUREAND SIZEOF GOVERNMENT FISCAL AND QUASIFISCAL OPERATIONS 1.3 Government fiscal operations in Uzbekistan are fragmented, which complicates measuring the size of the government and assessment of sustainability of fiscal policies. The authorities' definition o f the State Budget does not reflect revenues and expenditures o f extrabudgetary funds and accounts,' government expenditures financed by grants and external loans, either "budgetary" or "non-budgetary,"2 and does not comply with international standards for coverage and classification in some other respects (see Chapter 4). State Budget expenditures were 24.6 percent o f GDP in 2003. But if all officially reported extra-budgetary funds together with "budgetary" debt and grant-financed expenditures are added to the State Budget, consolidatedbudget expenditures would be 35.2 percent o f GDP (as shown inTable 1.1). Ifex- `The authoritieshave been streamlining operationsof extra-budgetary funds in 2003-04. Still, currently Uzbekistanhas over 20 extrabudgetary funds, o f which five - Pension Fund, RepublicanRoad Fund. State Employment Promotion Fund and Special Account of the State Property Fund. and Education Fund - are large, and overall expenditures of extrabudgetary funds account for 9 percent of GDP. Many budgetary organizations also have individual 'extrabudgetaryaccounts. External loans in Uzbekistan are either contracted directly by the government (in which case they are considered -`governmentdebt") or under government guarantees (in this case they become "government-guaranteeddebt"). Both government and government-guaranteed loans can be "budgetary" (Le., the repayment of these loans is done from the state budget) or "non-budgetary" (repaid by recipient enterprises from their own revenues). N o externally-financed investment is included in the State Budget. "Budgetary" loans, however. are reflected in the State Budget once their repayment starts. with both principal and interest repayments included in the state budget above the line, while "non- budgetary" loans are not. The majority o f Uzbekistan's external government and government-guaranteed debt stock outstanding (around70 percent as of end-2003) is "non-budgetary" debt. 1 Box 1.1: Reorienting Fiscal Policy towards Economic Growth and Poverty Reduction: Theory and Empirical I Evidence Economic theory, drawing on the latest "endogenous growth" models, lays out the following channels for the impact of , government expenditures on economic growth in the longer term: (a) direct impact through the increase in capital stock 1 via public investment; (b) indirect impact by (i)changing incentives for private sector capital accumulation and supply of labor; and (ii)influencing marginal productivity of physical capital and the skill level of the labor force (human capital). This suggests that growth enhancing fiscal policy would emphasize human capital-building education and health expenditures as well as investment in infrastructure. The empirical studies do generally show that educational I and public health status as well as public investment in basic infrastructure have a positive impact on economic growth. Weaknesses found in some empirical studies in the relationships between economic growth and public expendztures on education, health and investment are likely evidence of inefficiencies in these expenditures. This underscoresthe need to focus public expenditures on areas where the public goods and externality effects of public expenditures i s highest - primary (as opposed to tertiary) education, preventive health care and basic infrastructure (telecommunication, transport and irrigation). and where they would be complementary to, rather than crowding out, the private sector which is generally more productive. I The relationship between the overall and sectoral government expenditures and economic growth and social outcomes, i however, is non-linear. Social and infrastructure expenditures, as any other investment, face diminishing marginal l retums and are thus efficient only up to a point where the benefit from those expenditures becomes equal to the social marginal cost of raising budget resources. An exceptionally high level of government expenditures in one category, i such as on education in Uzbekistan, may be an indicator of such inefficiencies. The use of particularly distortionary taxation also reducesthis efficiency threshold. Most taxation, however, is inherently non-neutral (except for lump-sum taxes and some taxes addressing externalities) and any additional public expenditure must be tested against the net efficiency loss incurred by taxes financing it. The economic literature also provides evidence o f the importance of maintaining fiscal discipline. Expenditures financed through increases in the budget deficit which requires either inflationary monetization or debt financing leading to debt build-up and crowding out of private sector investment through pressure on interest rates and/or availability of credit to private sector have been shown to be particularly detrimental to economic growth. Fiscal policy aimed at increasing growth, however, is not necessarily tantamount to poverty reduction. A policy that increases savings and investment but forces the current generationto endure significant privation in order to finance the capital to be used by the next generation is an example of such fiscal policy. It is therefore essential to make sure that government expenditures are equitably benefiting the poor, and that a tax system does not discriminate against the ~ poor. By addressing poverty and inequality, the fiscal policy is also contributing to economic growth: the economic literature has compelling evidence on the adverse effect of inequality on growth, as the productivity potential of the poor cannot be realized without minimum social support. In addition to spending on the poor, however, governments can also promote poverty reduction by providing the poor with the opportunity to participate in - and benefit from - ~ economic growth, asset accumulation and infrastructure, as well as empowering the poor - making public institutions accountable. supporting decentralization and community development, and gender equality. Sources: Tanzi, V. and H.Zee "Fiscal Policy and Long-Run Growth," in IMF Staff Papers, Vol. 44, No 2 (June 1997), pp. 179-209; ' Easterly, W. and S. Rebelo"Fiscal Policy and Economic Growth," Joumal of MonetaryEconomics32 (1993), pp. 417-458; Agenor, P.-R."The Economicsof Adjustment and Growth," Academic Press,New York, 2000, pp.464-471, 503-504; Eken, S.; Th. Helbling, A. Mazarei "Fiscal Policy in the Middle East and North Africa Region," IMF Working Paper WP/97/101, August 1997, pp. 13-16; Gerson, P. "The Impact of Fiscal Policy Variables on Output Growth," IMF Working Paper WP/98/1, January 1998; "Unproductive Public Expenditures: A Pragmatic Approach to Policy Analysis," Pamphlet Series, No. 48, Fiscal Affairs Department, IMF, Washington, DC, 1995; "Attacking Poverty," World Development Report 2000/01, the World Bank, Oxford University Press, New York. 2001. penditures (including mainly capital investment) financed by "non-budgetary" government- guaranteed borrowing are taken into account, general government expenditures would increase further - to 38.7 percent in 2003. Unless indicated otherwise, the discussion below is based on consolidated budget expenditures with general government expenditures noted where appropriate. In addition to explicit fiscal operations, the authorities engage in quasifiscal activities by maintaining prices below market or cost-recovery levels in sectors such as energy and agriculture. The main components o f the general government in Uzbekistan and other resource reallocation instruments used by the Uzbek authorities are shown in Figure 1.1, 2 1.4 I n some areas, such as cotton growing and gold mining, the lack of publicly available information hinders the evaluation of publicfinancialflows. For example, there is only limited information on operations o f the off-budget Fund for Settlements for Agricultural Products Purchased for State Needs, established in late 1998, which is financed by cotton sales proceeds under the state order and is involved in pre-financing o f agriculture and some other fiscal operation^.^ Although the annually approved budget o f the Fund i s secret, the operations o f the Fund are apparently significant: it is estimated that advance and final payments for cotton, grain and rice from the Fund in 2002 amounted to around 6 percent o f GDP. Table 1.1: ConsolidatedBudget Expenditures, 1995-2003l (including extrabudgetary funds; percent of GDP) 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total expenditures andnet lending, 47.5 50.3 41.5 44.9 41.6 39.3 36.8 36.5 35.2 incl. extrabudgetary funds Total expendituresandnet lending, 38.1 39.9 32.5 34.5 31.6 29.9 27.5 27.5 26.1 excl. extrabudgetary funds Education 7.4 7.4 7.1 7.6 7.5 6.7 6.8 6.7 6.5 Healthand sports 3.6 3.7 3.3 3.2 2.9 2.6 2.6 2.5 2.4 Allowances for families with children 1.4 2.5 2.4 2.1 2.0 1.7 1.5 1.5 1.4 and low-incomefamilies Other socio-culturalexpenditures 1.9 1.5 1.0 1.1 1.1 1.1 0.8 0.7 0.8 Economy '4.3 4.7 4.1 3.9 3.6 2.9 2.2 2.3 3.0 Of which: Agriculture .. 2.4 2.9 2.4 1.5 1.3 1.5 2.0 Public administration 1.0 1.1 0.8 0.8 0.8 0.7 0.6 0.5 0.5 "CentraIizecY investment2 6.1 7.1 7.4 6.7 6.6 5.9 4.9 4.7 3.3 Of which: Education 0.4 0.1 0.3 0.3 1.8 2.5 1.0 1.9 1.8 Healthcare 0.0 0.0 0.0 0.0 0.2 0.2 0.2 0.1 0.1 Economy 2.1 2.6 2.3 1.9 2.0 1.2 0.9 1.0 0.6 Subsidies 1.1 1.3 0.8 1.0 0.8 0.5 0.8 1.1 0.8 Of which: Budget subsidy for 1.1 1.3 0.8 1.0 0.8 0.5 0.5 0.4 0.3 socially-importantpublic services Guarantee Fund .. 0.1 0.2 0.6 Subsidiesunder Res. 423 .. 0.2 0.5 .. Interest expenditure 0.1 .. 0.7 0.6 0.7 0.5 0.5 0.5 Lendingminus repayment',' 0.5 3.6 0.0 1.1 0.8 1.7 1.6 1.6 2.2 Other expenditures3 10.6 7.0 5.6 6.4 5.0 5.5 5.2 5.5 4.8 Expendituresof extrabudgetaryfunds 9.4 10.4 9.0 10.4 10.0 9.4 9.2 9.0 9.0 PensionFund 6.3 7.6 6.5 6.6 7.2 6.7 6.8 6.3 6.2 RoadFund 0.8 1.0 1.1 1.6 1.5 1.6 1.5 1.7 1.5 EmploymentPromotionFund 0.2 0.3 0.3 0.3 0.4 0.3 0.3 0.2 0.3 State Property Committee 0.9 0.9 0.5 0.3 0.2 0.3 0.4 0.1 0.6 Other extrabudgetaryfunds 1.1 0.5 0.6 1.7 0.8 0.6 0.3 0.6 0.6 ' Including "budgetary" government andgovernment-guaranteedexternalloans and "non-budgetary"government external loansbut excluding "non-budgetary"government-guaranteedexternalloanswhich are receivedand serviced by the enterprise sector andbanks. "Centralized"investmentreflectedin the consolidated budget is domestically financed.Investmentfinanced by external loans "budgetary" government and government-guaranteedexternal loans and "non-budgetary" governmentextemal loans is reflectedin "Lending minusrepayment." Includesmilitary and internalsecurity expenditures, which are classified. Source: IMF. Uzbek authorities, World Bank staff estimates. The annual budgets of the Fund have been classified in recent years (e.g., the 2003 budget was approved by COM Resolution 166-24 o f March 2003, whose contentswas not made public). Resources of the Fund are also distributed in a non-transparent manner (e.g., one resolution that governs the distribution (COM Resolution 428-66 o f November 2000) is also classified). 3 I I I I "General government" I I I I I I I I I I "Consolidated I II I budget" I II I I StateBudget Extrabudgetary Government and Interest (authorities' funds: "budgetary" on T-bills definition) Major(4) govemment- Smaller (>20) guaranteed borrowing -1 1 Non-budgetary I / government- I1 1 ' I guaranteed I I I I Off-budgetfund(s) Extrabudgetary I (e.g., Fundfor accounts of I I Settlementsfor I I Agricultural organizations I I Products) I I I Quasi-fiscal operations: I I I i)Energy I I ii)Agriculture iii)Financialsystem c. DECLININGBUDGETRESOURCEENVELOPE TAXPOLICYISSUES AND 1.5 Over the past five years there has been a considerable decline in budget revenues following the pattern observed in many other transition economies earlier. In the second half o f the 1990s, Uzbekistan had the second highest level of consolidated budget revenues in the CIS (after Belarus). Since 1998, however, a combination o f factors has led to a reduction in budget revenue by almost 9 percentage points o f GDP, from 42.5 percent to 33.7 percent (including extra-budgetary funds; see Table 1.2): e the authorities launched a process of reducing the tax burden to stimulate investment activities of enterprises. By 2004 the profit tax rate had been cut almost in half compared to 19994, the number of personal income tax brackets was reduced and the top marginal tax rate cut from 45 percent in 1999 to 30 percent in 2004 (see Table 1.3). Simplified and lower taxation was introduced for small and medium enterprises (SMEs) and agricultural producers. More recently, the authorities began reducing the rate o f The Social Infrastructure Development Tax introduced in 1998 and levied on broadly the same base as the corporate profit tax (net disposable profit) should be added to obtain a truer level o f corporate profit taxation. The maximum rate o f the Social Infrastructure Development Tax that can be set by the local authorities for 2004 is 8 percent, unchanged in recent years. 4 Table 1.2: Consolidated Budget Revenues, 1995-2003 (including extrabudgetary funds; percent of GDP) 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total revenues, incl. extrabudgetaryfunds 43.5 43.9 39.3 42.5 39.2 37.1 34.9 34.7 33.7 Total revenues, excl. extrabudgetaryfunds 34.6 34.3 30.1 31.1 29.4 28.0 25.9 25.7 25.1 Taxes on incomes andprofits 11.3 13.5 11.2 9.8 8.9 7.6 7.7 7.3 6.8 Enterpriseprofit tax 8.5 9.9 7.2 5.9 4.4 3.6 2.9 2.3 2.2 Social infrastructuredevelopment tax .. 0.3 0.3 0.3 0.5 0.4 Unified tax for small enterpriseswith .. 0.6 0.9 0.9 simplified taxation Fixed incometax for entrepreneurs .. 0.4 0.4 0.4 0.6 0.5 0.3 Personalincometax 2.8 3.6 4.0 3.6 3.7 3.2 3.3 3.1 3.0 Taxes on domestic goods and services 15.5 18.2 16.0 19.0 18.6 18.0 15.0 14.8 15.4 Value added tax 5.7 6.4 7.5 9.4 7.3 7.5 6.5 6.0 5.5 Of which: Imports .. 1.8 1.3 1.5 1.6 1.7 .. Excises 8.3 10.1 6.0 5.9 8.1 7.7 6.2 6.6 7.2 Of which: Alcohol .. 0.5 0.8 0.9 1.7 1.6 1.2 0.9 .. Tobacco .. 0.1 0.2 0.2 0.6 0.4 0.3 0.3 .. Cotton 4.3 2.2 0.6 0 0 0.1 0 0 .. Oil products 3.2 6.4 3.8 3.8 4.2 4.0 3.5 4.3 .. Petroleumconsumptiontax .. 0.3 0.4 Property,land, andresourcetaxes 1.5 1.7 2.4 3.7 3.2 2.8 2.4 1.9 2.3 Of which: Propertytax 0.7 0.5 0.8 0.9 0.9 0.9 0.8 0.5 0.7 Landtax 0.7 1.0 1.1 1.4 1.2 0.9 0.8 0.5 0.5 Ecologicaltax .. 0.7 0.6 0.6 0.6 0.6 0.6 Customs duties 0.9 0.6 0.7 0.6 0.4 0.7 0.6 0.7 0.9 Of which: Unified customs .. 0.1 0.2 0.2 0.4 0.3 0.3 0.5 paymentby individuals Other tax and non-taxrevenues 6.9 2.0 2.2 1.7 1.5 1.8 2.6 2.9 1.9 Revenues of extrabudgetary funds 8.9 9.7 9.2 11.4 9.8 9.1 8.9 9.0 8.6 PensionFund 6.3 7.6 7.0 7.1 7.0 6.5 6.8 6.4 6.2 RoadFund 0.9 1.1 1.1 1.6 1.5 1.6 1.5 1.7 1.6 EmploymentPromotionFund 0.3 0.4 0.4 0.4 0.5 0.3 0.3 0.2 0.3 Other extrabudgetary funds 1.3 0.6 0.7 2.3 0.8 0.7 0.4 0.7 0.6 Source: IMF, Uzbek authorities, World Bank staff estimates. social contributions and by 2004 these contributions - combined into a Unified Social Payment -were cut from 40 percent in2001-02 to a more moderate 33 percent. e weaker financial situation of enterprises, primarily in the period leading up to the formal announcement of convertibility in 2003, resulted in a decline in tax collections, particularly of profit-based taxes: DuringUzbekistan's delayed adjustment in 2000-03 following the Russian crisis, accumulation o f inventories by enterprises accelerated, accounts payables in industry more than doubled between January 1999 and January 2001 while the agricultural sector required major debt write-offs. erosion of the tax base through the spread of tax exemptions. In recent years, the number o f exemptions has considerably increased. Many o f these are designed to stimulate producers to achieve various government objectives such as expansion o f exports by producers (as opposed to traders), import substitution, promotion o f domestic consumer goods production, reduction of cash turnover, and attraction o f foreign investors. Many exemptions are ad hoc, extended to individual enterprises, and some individual exemptions are secret. The result of tax expenditures are substantial losses for the state budget uneven playing field? For example, in 2003 VAT on imports collected by the State Customs Committee were estimated at close to $150 million, or less than 6 percent of merchandise imports, although the statutory VAT rate is 20 percent. Similarly, 5 1.6 The level of revenues is now more consistent with Uzbekistan's revenue mobilization capacity but there is greater reliance on indirect taxes which may be more regressive. Future attention should be paid to improving tax policy and a more equitable distribution o f tax burden. In2003 indirect tax revenues, primarily VAT and excises, accounted for 13 percent o f GDP, the second highest level in the Table 1.3: Uzbekistan: Dynamics of Key Tax Rates, 1998-2004 CIS. Particularly striking (percent, as at the beginningof each year) has been a rise in the 1998 1999 2000 2001 2002 2003 2004 importance o f excise taxes in the late 1990s-early Corporate profit tax 35.0 33.0 31.0 26.0 24.0 20.0 18.0 2000s. In 2003 excise tax (standard rate) Personal income tax revenue in Uzbekistan lowest band 15.0 15.0 15.0 12.0 13.0 13.0 13.0 accounted for 7 percent o f highest band' 45.0 45.0 40.0 36.0 33.0 32.0 30.0 GDP, more than double o f number o f bands 5.0 5.0 4.0 3.0 3.0 3.0 3.0 the second highest excise- VAT 20.02 20.02 20.0 20.0 20.0 20.0 20.0 Unified tax for SMEs collecting country in the manufacturing 10.0 10.0 10.0 10.0 10.0 12.0 13.0 CIS. Excises in Uzbekistan, agriculture3 5.0 5.0 5.0 5.0 5.0 6.0 6.0 in addition to taxing Unified social payment4 40.0 40.0 40.0 40.0 40.0 37.2 33.0 demand-inelastic luxury and Pension Fund sales tax 0.5 0.5 .. 0.7 0.7 0.7 0.7 alcohol and tobacco items Property tax' 4.0 5.0 5.0 2.0 3.0 3.5 as in other countries, are ' The definition of the lowest band changed from up to 3 minimum wages in 1998-2000 also used to extract natural to up to 4 minimum wages in 2001 and 5 minimumwages in 2002. The definition of the highest band changed over time from over 15 minimum wages in 1998-1999 to over 10 resource rents from its minimum wages in 2000, over 8 minimum wages in 2001-02 and back to over 10 important oil and gas *minimumwagesfor in2003. The VAT rate some socially-important goods (bread, milk, etc.) was 10% in 1998 industries in addition to and 15%in 1999. regular taxes on mining. Except those payingunified landtax. Excises on oil and gas Prior to 2004 the sum of contributions to the Pension Fund, Employment Promotion Fund and Trade Union Fund. In addition, in 2000-04 employees pay 2.5% of their generate revenues o f over 4 wages to the PensionFund(in 1998 --1.5%, in 1999 2%). -- percent o f GDP, or more Starting from 2002, the property tax is levied on residual value of assets rather than than half o f excise tax original value as before. revenues6. In addition, Source: the World Bank based on annualbudgetresolutions. excises serve as an instrument of import protection as they are levied on a wide range o f imported, mainly consumer goods, but not uniformly applied to domestic goods. 1.7 Revenue leakagesand earmarking reduceflexibility infiscal policy making. A number o f taxes and non-tax budget revenues are earmarked for certain budget or even non-budget organizations. For example, shares o f certain excise taxes are earmarked for various industrial associations. Privatization proceeds are among the largest sources o f revenues subject to earmarking: only 40 percent goes for budget deficit financing. 1.8 The complexity and unpredictability of the tax system need to befurther addressed A Tax Code adopted in April 1997 laid out tax bases, payers and many o f the exemptions for 13 national and local taxes. However, in addition, there is a number o f taxes that have been adopted customs duties collected in 2003 amounted to around $90 million and represent only 3 percent o f merchandise imports, well below average statutory import tariff rate. For example, in 2004 oil and oil condensate were subject to a 25 percent excise and natural gas, except natural gas sold to households (Le., slightly less than half o f total produced), was subject to a 40 percent excise tax. On top o f these excises paid by extraction companies, gasoline was subject to excises averaging in 2004 45 percent. In addition, there is a separate petroleum consumption tax paid by retail consumers o f gasoline and earmarked to local budgets. From 2005, excises on oil and gas will be partly replaced by another form o f indirect taxation - higher sales taxes on natural resources. In particular. the sales tax on oil production will be raised from 12.3 percent to 35 percent. while the oil excise is abolished: the sales tax on natural gas production will be raised from 18.5 percent to 58 percent, while the excise tax on natural gas is cut to 19 percent. 6 by Cabinet resolutions (e.g., gross income tax for trading enterprises, unified tax for small and micro enterprises, taxes payable to extrabudgetary funds - the Pension Fund, Employment PromotionFund, RoadFund, etc.). Tax rates are rather unstable. Many tax rates were set in the Tax Code only indicativelyand the Cabinet was delegated the right to set the specific rate. As a result, almost all tax rates, except for personalincome tax andVAT, are set by the government in annual budget resolutions adopted by the Cabinet in late December, which have become essentially mini-Tax Codes.7 The tax system also combines elements of value-added taxation with sales taxation. For example, in additionto a VAT, legal entities are subject to a combined 3.2 percent sales tax payable to the Pension Fund, Road Fund, and EducationFund. There has been some movement towards simplifying the tax system by merging certain taxes in recent years, but the system remainscomplex anda thorough tax review is needed. 1.9 Some administrative tax collection methods make the business environment for enterprises more difficult. According to official data, there are no budgetary offsetting operations and tax arrears are remarkably low and declining (from 0.7 percent of GDP in early 1999to 0.2 percent in 2003). However,the pervasive state controlandtax enforcement methods such as the use of commercial banks for tax reporting8and collection (e.g., through debiting accounts of tax debtors without the account holder's acceptance) are among the factors that contributeto the unfavorable businessenvironment inUzbekistan.' D. TRENDS GOVERNMENT IN EXPENDITURES 1.10 As consolidated budget revenues shrank, government expenditures have been cut substantially. Between 1998 and 2003 consolidated budget expenditures, including extra- budgetary funds and net lending, were cut by around 10 percentage points of GDP, to around 35 - - percent of GDP in 2003 (Figure 1.2). Compared to the mid-1990s the cut is Figure 1.2: Consolidated Budget, including even more significant - 12-15 Extrabudgetary Funds, 1995-2003 percentage points of GDP. General 6o I *. [=IConsolidatedbudgetrevenues government expenditure, which also 55 * . +Consolidated budget expenditures includes spending, mostly investments, I financed by "non-budgetary" government and government-guaranteed borrowing, also saw dramatic declines during the period. Nevertheless, the level of, government spending in Uzbekistan is still higher than in most I countries at its per capita income level and many fast growingcountries of East 1995 1996 1997 1998 1999 2000 2001 2002 2003 Asia and LatinAmerica(Figure 1.3). * Includes expenditurefinancedby "non-budgetaly"govemment and govemment- guaranteedborrowing (valuedat the offncial exchangerate). 'For example, the 2004 budget resolution is 76 pages long, four-fifths of which is dedicatedto setting various tax rates. For example, the Central Bank of Uzbekistan (CBU) instruction issued in 2002 orders that all payment transactions of legal entities over a threshold of a few thousand dollars be reported by commercial banks to the CBU and tax inspectorate. A resolution of the CBU, tax and customs authorities issued in late 2003 orders that certain companies applying for foreign exchange for certain purposes (e.g.. to make an advance payment on import of over 15 percent of contract value) be reported to the authorities and the tax authorities are obliged to consider inspecting them within several months. There are also reports from businesses about unofficial ad hoc levies collected by local authorities for charity, local infrastructure development, holding various events. 7 1.11 Government expenditure cuts have been broadly spread with only education and pension spending relatively little affected. Major cuts have taken place since the mid-1990s in centralized investment outside o f education and spending on the economy (Figure 1.4), accounting for almost half o f the decline in consolidated budget expenditures. Figure 1.3: Government Expendituresand Non-education social spending, Per Capita Incomes in Low and Middle- including health care, social protection, Income Countries (2000-02 averages) and pensions, accounted for around 30 6o 1 Bosnia percent o f decline in consolidated budget expenditures during the period. While overall expenditure and most major government expenditure S. Korea categories were cut, total expenditure on + education has in fact increased. The increase was primarily due to the sharp increase in investment, especially I 0 domestically-financed, since the 0 5,000 10,000 15,000 20,000 adoption of the NPPT (see Chapter 3). I US$ GDP per capita (PPP) Sources. World Bank's Unified Survey and IMF , The extremely high education expenditures are the main reason for the high share (around 55 percent in recent Figure 1.4: Main Sectoral Expenditures of the Consolidated Budget, 1995-2003 years) o f social expenditures in total 10 consolidated budget expenditures in Uzbekistan. While Uzbekistan's health and social protection (including pension) spending i s in line or below the more advanced transition economies, its 3 - education spending at 8-to-9 percent of 2 - GDP is not only by far the highest 1 - among the transition economies, but 0 1995 1998 1999 2000 2001 2002 2003 also higher than in any European Union +Education1996(incl.1997 domestically-finaced("centralized") public investment) +Other social expenditures(excl. pensions) country, and alone accounts for close to PensionFund "i) Domestically-finaced("centralized") public investment(excl. education) a quarter o f consolidated budget +Economy* * Agriculture and irrigation account for around half ofspending on economy. spending (see Chapter 3 for an in-depth discussion'o f education expenditures and policies). 1.12 As state quasi--seal activities declined, some explicit forms of support to enterprises were included in the budget. After budget subsidy cuts in the early 1990s, Uzbekistan's state budget had few explicit subsidies". With the major devaluation starting in 2000, which affected the financial standing o f some enterprises, however, the authorities have fiscalized a small portion o f previous quasi-fiscal activities by extending time-bound support to vulnerable enterprises with large net imports and external debt service obligations in late 2001-02 in the amount o f 0.7 percent o f GDP." More recently, support to enterprises for debt service through the Guarantee Funds has risen, quadrupling in 2003 compared to 2002 to over $50 mn. (0.6 percent o f GDP). This is only a small share o f over $0.5 bn. in repayments on "non-budgetary" government- guaranteed debt by enterprises and commercial bank in 2003. The risk to the government's fiscal position from a larger share o f repayments on these contingent liabilities falling onto the consolidated budget is therefore high. loWhether any such subsidies are contained inthe '.Other" expenditure category is not known. "UnderCOMResolution423 ofOctober2001. 8 E. ECONOMIC COMPOSITION OF CONSOLIDATED BUDGET EXPENDITURES. 1.13 The total government wage bill is diffult to estimate but appears quite sizable. Wages and associated social contributions in budget organizations - social sectors and public administration - accounted for 6.6 percent o f GDP in 2003 (Table 1.4). This i s higher than in other lower-income CIS Table 1.4: Consolidated Budget Expenditure, 2000-2003' countries'* where the public (economic classification, including extrabudgetary funds; wage bill averages under 4 percent of GDP) percent o f GDP, although, as a 2000 2001 2002 2 G 7 share o f total consolidated Total expenditures and net lending; incl. 39.3 36.8 36.5 35.2 budget expenditures, wages and extrabudgetary funds social contributions are similar Wages and other staff expenditures 7.6 7.4 7.0 6.9 (19 percent in Uzbekistan vs. 17 O f which: Wages' 4.9 4.9 4.8 4.8 percent), given the higher Social contributions 1.9 1.9 1.9 1.8 overall level o f government Travel expenses 0.1 0.1 0.1 0.0 Stipends 0.7 0.5 0.2 0.2 expenditure in Uzbekistan. Goods and services 1.2 1.4 2.2 2.7 Compared to the higher-income Food 0.9 1.1 1.0 1.0 CIS countries, wages as a share Medicines 0.3 0.3 0.3 0.3 of GDP in Uzbekistan is not Energy .. 0.9 1.5 Interest 0.7 0.5 0.5 0.5 significantly different. Transfers 8.7 8.5 8.1 8.0 However, the wage bill above i s O f which: Pensions Fund 6.7 6.8 6.3 6.2 an underestimate since it does Subsidies 0.5 0.7 0.9 0.4 not include wages in the Capital investment4 7.5 7.0 6.9 5.1 military and internal security O f which: Road maintenance and 1.6 1.5 1.7 1.5 construction services which are covered in Lending minus repayment' ' 1.8 1.1 1.1 1.9 the "other expenditure" category Other expenditures6 11.4 10.2 9.7 9.7 and because many ministries ' Including "budgetary" government and government-guaranteedexternal loans and and government agencies have "non-budgetary" government external loans but excluding "non-budgetary" extra-budgetary funds which government-guaranteedexternal loans receivedand serviced mostly by the can be used to pay wage enterprisesector. Estimatedbasedon government projections. supplements and bonuses to Including public works and administrationexpenditures of the Employment staff o f respective ministries. PromotionFund. 'Including investmentfinanced by external "budgetary" loans. Including lending forjob-creation by the EmploymentPromotion Fund. 1.14 The wage bill appears "Other" expenditures alongthe economic classificationincludes classified to have been protected from military and internal security expenditures, acquisitionof assets, repairs and certain cuts in recent years. Over the subsidiesnot economically classifiedby the authorities, as well as spendingof extrabudgetary funds other than the PensionFund, Employment PromotionFund period for which the economic and RoadFund. classification is available (2000- 03), wages and social Source: IMF, Uzbek authorities, World Bank staff estimates contributions as a share of GDP held steady, reflecting an implicit indexation policy pursued by the authorities until recently. Between 1999 and 2002 wages were raised on average by 45 percent in nominal terms. And until late 2002 wages at enterprises o f all forms o f ownership were governed by the same unified wage grid as wages in budget organizations, thus leading to a wage-inflation spiral. The compression ratio o f public sector wages - the ratio o f minimum to maximum wage band - in Uzbekistan is 9.0,13 close to 10 which, based on international experience, provides adequate incentives for '* Azerbaijan,Armenia, Georgia, Kyrgyz Republic. Moldova. and Tajikistan. l3 Wages at budget organizations in Uzbekistan are governed by a unified tariff grid. The grid was introduced from January 1993 with 29 bands depending on seniority. From April 1996 the number o f bands was reduced to 22. The lowest (zero) band is defined as a minimum wage and subsequent bands are multiples o f the minimum wage (since August 1" 2004 the minimum wage is 6,530 soums: or around $6). From August 2004 the top band is 9.019 o f the 9 improved performance by budgetary emp10yees.I~ On the other hand, the average wage in budget organizations remains low, $40 a month in 2003. This affects the ability o f the government to attract qualified staff in certain specialties, although perhaps not to such an extent as in other transition economies with more developed private sector opportunities and where the public- private wage differential i s greater. 1.15 Employment at (non-military, non-security-related) budget organizations in recent years did not change substantially, and remains concentrated in the health and education sectors. Between 2000 and 2003 it increased by around 2 percent compared to the official growth o f total employment in the economy o f 7 percent during the period. At around 1.6 million, employment at budget organizations accounted for around 17 percent o f total employment, with 95 percent o f those employed inhealth care, education and sports. 1.16 I n recent years the authorities have undertaken several attempts to trim the size of employment at budget organizations. In September 2002 the workload for teachers in secondary scho01s'~was increased by 25-30 percent without a corresponding adjustment in wages. The expectation was that this would lead to a reduction in number o f those employed in education and result in budget savings which could be used to raise wages for remaining employees in the sector. In practice, however, the staff numbers in education declined very little. In 2003 a Republican commission was created to prepare proposals for administrative reform and improvements in economic managementI6. The Commission's work has resulted in the adoption o f several Cabinet o f Ministers' resolutions and Presidential decrees" cutting staff at budget organizations and head offices o f industrial associations and management personnel at state- owned enterprises, and abolishing or restructuring several industrial associations. As a result, staff o f central and local governments, ministries and agencies was cut by close to 8 thousand (around 10 percent). 32 thousand more was cut at industrial associations and state-owned enterprises. Similar reductions were attempted in the past. However, they slowed - but did not reverse - the growth o f public-sector employment. It was reported that this time the authorities also planned to review government functions rather than individual staff positions, which would hopefully result in a more sustained reduction in government bureaucracy. 1.17 Public investment has declined, especially in 2002-03. Since independence the authorities have undertaken significant public investment, primarily in industry and infrastructure, in order to move to a more industrialized structure o f the economy. In 1996-2003 public investment averaged around 12 percent of GDP, including investment o f around 5 percent o f GDP financed by government and government-guaranteed external borrowing which took place outside the budget. Public investment during the period accounted for almost half o f total investment in the economy. By 2003 public investment had fallen to around 8 percent o f GDP, but was still higher than inany other transition economy, except for Belarus and Turkmenistan. 1.18 Efficiency of public investment needs to be improved Uzbekistan's average incremental capital-output ratio (ICOR) in 1996-2003 was 7.2 (Table 1.5) compared to the ICOR o f around 4 minimum wage (COM Resolution 309 of July 2004). The job assignment to a specific band is decided by the respective line ministry together with the Ministry of Finance, Ministry of Labor and Social Protection, and trade unions. On top of the grid wage, employees in certain sectors receive additional payments: 20 percent of wage in the state government,30 percent in Universities, 5 percent for work in secondary schools. etc. l4Gupta, S., L.Leruth, L. de Mello, Sh. Chakravarti, "Transition Economies: How Appropriate i s the Size and Scope of Government?." IMFWorking Paper WPIOIAS, May 2001. ''Defined as the number of hours to be taught by ateacher per week. l6Presidential Order R-1791 of June 2003. E.g., COM Resolutions 363 ofAugust 2003 and 520 ofNovember 2003, Presidential DecreesUP-3358 and UP-3366 of December 2003. 10 for Kyrgyz Republic, Tajikistan and Kazakhstan for the period since the end o f their transition recessions. The five-year average ICOR for low- and middle-income countries with export orientation and high rates o f economic growth for period 1970-1995 was also equal to 4.0." While the average efficiency o f investments measured by ICOR improved in Uzbekistan during 2001-03, particularly in industry, it still remained low by international standards. Judging by ICORs, the relative efficiency o f investments in Uzbekistan was highest in agriculture, trade and catering, and construction, and lowest in industry, even though industrialization was the highest priority inthe authorities' investment policies. 1.19 The public investment program is oriented Table 1.5: Efficiencyof Capital Investment by to support an import-substitution strategy. Sector, 1996-2003 Uzbekistan's public investment program has a ICOR significant concentration o f projects in industry (1996-2003 (around 30 percent o f public investment went into average) industry in 1996-2003), especially heavy industry, Overall ICOR for the economy: 7.2 energy, and chemical and petrochemical industries, Industry 37.3 which work mainly for domestic market and well Agriculture 1.2 below their capacity utilization. International Construction 0.9 experience demonstrates the relative inefficiency o f Transport & communication 16 investments and economic performance under Trade & catering 1.2 import-substitution policies. For example, real GNP Other services 14.3 and manufacturing export growth in countries with strong export orientation were four times higher and Note: ICOR is the ratio of the share of investments in GDP to GDP growth rate [ICOR' = 100*(Nominal efficiency o f investment two times higher than in Investment/ Nominal Value-Added)'" /Real growth of countries with strong import substit~tion.'~ The the Value-Added '1. The lower an ICOR, the more efficient investments. agriculture sector has received only around 12 percent o f public investment since 1996, even Source: World Bank staff calculations. though rural areas account for over 60 percent o f population and 70 percent o f the poor. 1.20 Project selection needs to be strengthened to increase the efficiency of public investment. Proper evaluation procedures for public investment projects were introduced in 1998 and were further strengthened in 2003, but the cost-effectiveness o f earlier projects may be doubtful. Moreover, there are questions about the extent to which formal evaluation procedures are applied in practice, and there are cases o f weak market research during investment project selection. For example, the project to launch production o f Poliamid-6 at the Ferghana Chemical Fiber Plant was completed in 1997 at a cost o f DM102 million. The feasibility study for the project priced output at US$3,000-3,500 per ton, but in practice the output could not be sold even for US$SOO per ton with obvious implications for returns to the project.20 In addition, the evaluation o f foreign exchange risks was weak. Some projects in 1998-99 had been appraised at the official exchange rate o f 200-300 Soum per U S dollar, despite the parallel market premium reaching several hundred percent towards the end o f the period. The sharp devaluations o f the soum in 2000-02 could not be envisaged in those appraisals. 1.21 Inadequateproject cost estimation at theproject design stage an,dcost overruns during the project implementation have also been problem areas. The government's monitoring unit discovered that for a number o f public investment projects original cost estimates were inflated. Cost "World Economic Outlook: Asset Prices and the Business Cycle": International Monetary Fund, May 2000. p.128 (http://www,imf.ordextcrnal/pubs/ft/aeo/2000/01/index.htm) *'World l 9 DevelopmentReport 1987,The World Bank, pp. 82-89. "Industrial Policy: Experience and Application in Uzbekistan,'' Report 1999115, Center for Economic Research, Tashkent, 1999 (http://\i'u'w.cer.uz) 11 overruns are also widespread. The main reasons for project cost inflation and overruns are intentional overstatement o f volumes and values of construction works at project design stage, unreliable economic data used for feasibility studies, the practice by local authorities o f starting construction work in parallel with project design, limited use o f competitive and transparent tenders in construction, and absence o f a mechanism for requiring completion o f works at the original tendered pricee2* F. REDUCTION QUASI-FISCAL IN OPERATIONS 1.22 The authorities widely used quasi-fiscal instruments to pursue their industrialization and economic development objectives but in thepast 2-3 years quasifiscalactivities have been dramatically reduced. A major source o f quasifiscal operations affecting virtually all sectors o f the economy was the foreign exchange regime with multiple exchange rates and currency rationing. By subsidizing priority industries and population at the expense o f some other sectors, these quasifiscal operations produced major relative price distortions and blunted incentives o f economic agents. In the late 1990s and early 2000s the implicit subsidization, including through low prices o f energy, state order crops in __ ~ agriculture, government guarantees and Figure 1.5: Select Quasifiscal Activities, 2001-2003" multiple exchange rates, was very high ' "1 (Figure 1.5). Since then, the authorities have undertaken a major price g 2 0 adjustment and tightening o f payment 2 I discipline in the energy sector, cutting implicit subsidies provided by the sector K by more than 10 percentage points o f GDP, unified exchange rates, 1 eliminating provision o f subsidized , foreign exchange, and raised state order ' o ____~_ 2001 2002 2003 ~~ prices o f cotton and wheat in real terms. ' 0Implicit import subsidiesthroughthe multipleexchangerate regime 1Quasi-fiscalactivitiesintheenergysector The size o f quasifiscal operations has * At the indicahveexchangerate. I substantially declined as a result. Source.World Bank and IMF staffcalculahons. _ _ _.~ G. FISCAL ADJUSTMENTAND SOURCESOF BUDGETFINANCING 1.23 Deficits of the consolidated budget' have been moderate and declining, but in 2003 there was an increase in budget arrears. Since 1997, annual deficits have been below 3 percent and since 1998, as expenditure cuts have exceeded revenue declines, have been on a declining trend falling by 2003 to 1.5 percent o f GDP (Figure 1.6). In2003, however, there was reportedly a significant build-up in budgetary arrears in wage and pension payments, estimated at over 1 percent o f GDP. On the other hand, there was a significant accumulation o f government deposits, both with commercial banks and the CBU.23 According to the authorities, by the end o f 2004 pensions and wages to employees o f budget organization were being paid on time. *'For a more detailed discussion of state procurement in Uzbekistan and recommendations regarding its improvement, see "Uzbekistan: Country Procurement Assessment Report," Report No. 25653. The World Bank. Washington, DC, February2004. 22Which excludes investment financed by "non-budgetary" government-guaranteed borrowing. 23 This reportedly occurred when expenditures recorded as fully funded by the consolidated budget could not be withdrawn from accounts of budget organizations due to the widely reported restrictions on cash-uithdrawals. Another source of increased government deposits is reportedly an increase in off-budget revenues from exports of non-ferrous metals. primarily gold. which rose invalue terms as a result of strong world market prices. 12 1.24 Estimates of the real public sector operational balance24 indicate Figure 1.6: Narrow and Broad Government Deficits, that an even larger fiscal adjustment 1996-2003 has been undertaken since the late 0 1996 1997 1998 1 1990s. In 1998-99 large-scale public -* . - - ..-. investment in industrial and development projects financed by external "non-budgetary" government- I guaranteed borrowing brought the real public sector operational deficits close to 10 percent o f GDP.25 As debt service rose, the authorities sharply tightened 4 Consolidated budget deficit their borrowing policies (see para 1.26) (from above the line) &Real public sector operational deficit (incl. "non- and cut the broad real public sector budgetary" government-guaranteed borrowing) - operational deficit by two-thirds in 2000. -16 By 2003 the broad deficit was reducedto 2.1 percent of GDP. 1.25 The tightening of the public sector fiscal position may also reflect the limited availability of domestic and externalfinancing. For years, the authorities relied on monetization o f the deficits. State Budgets approved inthe second half o f the 1990s envisioned CBU financing o f the budget o f 1 percent of GDP. These zero interest rate credits contributed to persistent inflation (GDP deflator averaged 48 percent in 1997-2002). the authorities started to reduce C B U financing o f the budgets - to 0.5 percent o f GDP - in 2001.26 In 2003 the C B U lending to the government was discontinued completely. Together with tighter public wage policies (as discussed above) and cash rationing, this led to a substantial reduction in inflation with the GDP deflator going down from 45 percent in 2002 to 24 percent in 2003. Non-inflationary domestic sources of financing have also been limited. Annual privatization proceeds averaged less than half a percent of GDP during 1997-2003. The domestic debt market development initiated in the mid-1990s has also been hamstrung by generally below-market interest rates offered, exchange rate instability and a forced roll-over in 2001. 1.26 I n the 1990s the authorities relied heavily on external government and government- guaranteed borrowing tofinance their economic development and industrialization program, but since 2000 external borrowing had to be cut. Overall during 1992-2003 the government attracted $9.8 bn. in loan commitments directly or under government guarantees. External government and government-guaranteed debt growth was rapid in the 1990s (Figure 1.7) but since 2000 the authorities adopted substantially more conservative external borrowing policies. 24The concept of the broad real public sector operational deficit is designed to capture the possible fiscal operations carried out by the Central Bank as well as explicit contingent liabilities in the form of "non-budgetary" government-guaranteedborrowing. The broad real public sector deficit is estimated from below the line based on the total expansionof private sector credit to the government as measured by the reserve money less Central Bank credit to the non-government sector, plus domestic and external debt issuance by the public sector and proceeds from asset transfer to the private sector, all adjustedfor domestic and foreign inflation and real exchange rate movements. 25The external debt stock changes are valued at the official exchange rate for consistency with monetary statistics. The true economic value of external borrowing during the period was much higher since the official exchange rate at the time did not reflect market realities (the gap betweenthe administratively-controlled official exchangerate and parallel market exchange rate averaged over 300 percent in 1999). At the indicative exchange rate, the nominal broad public sector deficit would be as high as 14 percent in 1999. 26Although the annual budget resolutions of the Cabinet of Ministers for 2001 and 2002 envisioned CBU credits to the government of 0.5 percent only, during the two years the CBU provided additional financing for the government`s operations by extending (under Resolution 423 of October 2001) directed loans to net importers and enterprises with external debt that were especially adversely affected by the official exchange rate devaluation in the fall of 2001. These directed loans were capped at 0.5 percentof GDP per annum. 13 Starting in 2002 the annual state budgets have included an explicit provision that the amount o f foreign government and government-guaranteed commitments signed should not exceed the amount o f government and government- r .___ guaranteed debt service coming due Figure 1.7: Government and Government-Guaranteed during the year, and in 2003-early 2004 Debt and Debt Service, 1995-2003 (billion US dollars)* stricter rules for issuance o f government 5.0 ~ r 0.8 guarantees on external borrowing were 4.5 0.7 also adopted. As a result, since 2000 4.0 3,5 0.6 external government and government- 3.0 0.5 guaranteed external debt stock has 2.5 0.4 stabilized and, given that borrowing ' 2.0 from commercial and bilateral sources 0.3 1.5 declined since 2000, there has been a 0.2 relative shift towards more concessional 1.0 0.5 0.1 1 credits. Government and government- 0.0 0.0 guaranteed debt service' however' is 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 relatively high, around 20 percent o f * Includingdisputed part debt to the RussianFederation of ($0.46 bn.) exports o f goods and services, the ---~ ___. highest in the CIS, a reflection o f heavy reliance on commercial credits and relatively short maturity profile and low concessionality o f external debt2'. 1.27 A recent rise in world market prices of Uzbekistan's main export commodities has improved the country'sfinancial situation but for a sustained improvement in Uzbekistan's sovereign creditworthiness which would increase foreign financing, a reorientation of economic strategy and the role of government is needed. In 2003, the world market prices of gold and cotton rose sharply, contributing to the growth o f exports o f goods and services by 27 percent in value terms and boosting foreign exchange reserves by over 0.4 bn. The exchange rates were also unified and stabilized. As a result, all o f Uzbekistan's external debt ratios improved and were below their values in 2000 when external borrowing was tightened. The world market prices, however, are volatile. The key factors for improvement o f Uzbekistan's creditworthiness are, in addition to the continued tight borrowing policies o f recent years, an improved environment for economic growth, diversification and a further sustained increase o f exports. This will be hard to achieve without a reorientation from the current inward-oriented strategy based on the dominant role o f the state to a more open, market-oriented development strategy. H. CHANGINGTHEROLEOFTHE STATEINUZBEKISTAN 1.28 Despite the reduction in the size offlscal and quasifiscal operations over theyears, the role of the state in the Uzbek economy remain very high. The state continues to be involved in a wide range o f off-budget economic activities managing whole sectors o f the economy such as cotton growing. Instances such as when the authorities require enterprises to perform special works, for example by providing employees for cotton picking, point to a much larger influence o f the state than is indicated by the quantifiable fiscal and quasifiscal operations. If control over the economy through parastatal industrial associations, local authorities (hokims), and state-owned commercial banks, as well as heavy regulatory burden are added, the reach o f the state is greater still. The choice o f instruments for state intervention also leans towards direct *'The present value of total Uzbekistan`s external debt, excluding disputed portion of debt to the Russian Federation, i s estimated at 94 percent of face value o f government and govemment-guaranteed debt at end-2003, comparable to Kazakhstan's but well above the 77 percent unweighted average for the other CIS-7 countries. 14 intervention, administrative measures and service provision by the state rather than private sector provision where it may be viable. The administrative and regulatory pressure on the economy in some areas such as trade regime and domestic cash management has been on the increase in recent years. As international experience, and Uzbekistan's own growth and living standards performance over the past decade indicate, such a high level of state intervention i s not consistent with rapid, sustainable economic growth. 1.29 By focusing constrained technical and financial resources on performing the core functions of the state in a market economy - provision of public goods, addressing market failures, reducing inequity and ensuring macroeconomic stability, the Uzbek authorities could increase effectiveness of the state while letting the private sector make its contribution to economic growth.'' An improvement in transparency and accountability of government agencies, extension of checks and balances on the authority o f the executive, and introduction o f competitive forces and performance-based remuneration within the civil service are also needed to align the incentives for the government in Uzbekistan to better work towards the collective interests o f the society. 28"The State in a Changing World," World Development Report 1997, the World Bank, New York, Oxford University Press, 1997. 15 CHAPTER 2. HEALTH A. INTRODUCTION 2.1 Since the start o f the transition period, Uzbekistan, like many former Soviet republics, has had to address the challenge o f reforming a once generous universal health care system in the face o f budgetary contractions. Commendably these reforms have acknowledged the constraints on the fiscal sustainability o f the existing public system while balancing the constitutional rights o f citizens to equal access to health care services delivered by qualified personnel. This chapter reviews health sector expenditures and provides suggestions towards achieving reform goals, aimed at improvingthe efficiency and equity o f expenditures. B. GOVERNMENT REFORMS 2.2 The health sector is evolvingfrom its Soviet period heritage. Currently the financing and organization of health service delivery involves multiple levels o f government and institutions. The State has maintained its role as overseer o f the health sector through the Cabinet o f Ministers (COM), who is responsible for the direction o f the health system reforms and national health priorities with their decisions ultimately approved by the President. The role o f organizing and managing the health system i s the responsibility o f the Ministry o f Health (MOH) while the Ministry of Finance (MOF) approves and allocates budgets for health care, financed from general government revenues, based on a set o f input norms (such as number of beds, and staff slots). The budget at the facility level is provided in four categories, down from about 18 line items previously. There i s also some limited flexibility now to reallocate and carry over funds into the next fiscal period (see Chapter 4). 2.3 The health care system is movingfrom afragmented, centrally planned andfinanced system to a more integrated and mixed public and out-of-pocket payments system. Health service delivery is devolved primarily to the regional (oblast) and municipal (rayon in rural areas) facilities, although some services continue to be delivered vertically through Republican facilities (primarily for tertiary and specialized care) and a "parallel" system for employees o f certain ministries (defense, external affairs) or enterprises (mining). These parallel systems are being integrated within the larger MOH-run system o f care, with a few exceptions such as in Navoi region. Delivery is still dominated by large, specialized impatient facilities, although gradually primary health care is being strengthened. 2.4 Major reforms of the Uzbek health system, aimed at opening the system to wider private sector involvement while providing a package of free medical care, were initiated in 1998 (see Box 2.1). Box 2.1: Health Care Reform Objectives and Planned Actions for 1998-2005 Goals ofhealth care reforms 1. Observance of constitutionalrights of citizens to obtaining qualified medical aid and social protection. 2. Equal access to medical services for all citizens. 3. Provision of state control over the health condition of the population and its habitat. 4. Health system reforms to introduce market principles and mechanisms. 5. Establishmentof an effective system of matemal and child health protection. 6. Prioritizing the development of preventive health care services, wide promotion of healthy lifestyles, healthy nutrition and physical training. 7. Free-of-chargeemergency medical care is to be combined with a gradual transition of specialized and general-purpose health care facilities to chargeable services and the 16 development of a medical insurance system. 8. Stimulating private medical practice. 9. Increasingthe effectiveness of budget spendingfor health care. Planned actions to achieve goals 1. Provision of guaranteedlevel and quality of primary medical care to the population by the State. 2. Strengthening the system of emergency medical aid. 3. Improvementof the system of organization and allocationof health care network, gradual transition to GP system. 4. Establishment of amarket ofhealth care services. 5. Increasingthe effectiveness ofthe health care management system by simplifying it, granting more flexibility to health care facilities, development of non-governmental and private sectors. 6. Improvingthe financial base of the health care system by increasingthe effectivenessof budget spending for free medical services, developmentof various forms of mixed and private financing. 7. Establishment of a legal base for the health care reforms. 8. Improvementof the processof training, re-training and advancedtraining of medical workers. 9. Integration of developmentof physicaltraining and other forms of preventionmeasures for the population. 10.Development of international cooperation and attraction of foreign investment. Financial implications 1. Additional capital costs for the construction and renovation of emergency centers and SVPs. 2. Additional recurrent costs for the running of the newly establishedfacilities and services. 3. Savings on recurrentcosts from the closure of facilities. 4. Savingsfrom reduced budgetfinancing to the 467 hospitals identified to fund 80 percent of budget chargeable services 5. Non-recurrenttransactioncosts due to system reforms. Source: Presidential Decree (UP-2107) ofNovember 10, 1998 2.5 Some key changestofinancing and service delivery have resultedfrom these reforms: 0 Progress has been made in mainstreaming many o f the parallel enterprise facilities with the public system and in flattening the multi-tier structure o f service delivery, particularly for out-patient care. The number o f small rural hospitals (SUBS),midwifery stations (SVAs) and paramedic stations (FAPs) have decreased. These have instead been replaced by the rural doctor station SVPs which are increasing in number to improve access to basic primary care across the country. 0 The Government has invested in the development o f primary care and emergency centers which are both part o f the package o f free care to be covered by public funding: o The Government introduced, on a pilot basis in three regions (Ferghana, Navoi and Syrdarya), greater financial and organizational autonomy at the oblast, rayon and facility level, incentive-based financing and closure o f redundant facilities. This involved a pooling o f funds for primary care at the oblast level and direct (adjusted) per capita financing o f the primary care centers (SVPs) from oblast administration^.^^ These reforms reduced one layer o f administration (rayon level) in financing and improved the availability and use o f resources at SVPs (relative spending on staff, equipment and drugs). 29This project. Health I,was supported by a World Bank loan. The primary care reforms are to be rolled out country- wide and will be supported by a second World Bank loan and an Asian Development Bank (ADB) loan. 17 o The emergency care system was established in 2000 and is still being ~ompleted.~'It is not clear from a clinical perspective why a separate vertical system of emergency services was built, instead o f providing emergency services as part o f general hospitals. But this system does establish a basic package o f services covered by the Government. Chargeable services are not allowed at emergency centers. Each oblast and most rayons have or will have an emergency center. 0 Beyond primary care and emergency care services, the public benefit package is being reduced, especially for high-end specialist services. As a result, many hospitals are now planning for self-financing. All facilities, except those offering emergency and primary care services, are to self-finance 80 percent o f their budget. It was initially anticipated that this would be done by 2005, but a longer transition period i s likely. For patients to receive a required service free o f charge to be covered by the 20 percent o f government funds, a letter o freferral is needed.31 c. KEYISSUES AND CHALLENGES 2.6 Health Outcomes:Changes in the health status o f the Uzbek population are mixed, with improvements in some indicators but deterioration in others.32 Confounding a clear understanding o f health status is conflicting data from different sources (see Box 2.2). If greater credibility i s placed on household survey results, then the mortality and morbidity levels are o f concern as they are significantly higher than official data as well as the MDG targets, and the trends do not show any significant improvement. 2.7 Tackling these priorities would require emphasis on a program that targets the poor and rural population as well as increasing efforts on public health. The infant mortality rate (IMR)and under-5 mortality rate (USMR) inrural areas is almost twice that inurban areas. Both mortality rates are also higher amongst those who have great difficulty making ends meet, with a poorhich ratio of 1.1 for both indicators. While the Government's reform agenda to strengthen primary care is an important part o f improving access to health care for rural and poor populations, the fact that early reforms tended to benefit better-off regions and basic infrastructure is lacking for a number o f the SVPs reinforces the need for further progress to reach stated goals. 30The development of these emergency services was aided by a $15 million credit line from the Government of Spain and a $10 million grant from the Government of Japan to equip emergency services. 3'Those patients who should obtain a referral letter include those already exempt from paying user fees: low-income families; widows with several children, veterans of the war in Afghanistan, victims of the Chernobyl nuclear accident and people suffering from chronic conditions (diabetes, asthma, tuberculosis). User fees are reduced by 50 percent for those affected by occupational diseases and by 20 percentfor pensioners. 32 For example, the Standard Death Rate (SDR) for infectious and parasitic diseases, as well as under 5 SDR for diarrhoeal diseases and acute respiratory infections. pneumonia and influenza have all decreased since independence. although the latter remains particularly high relative to neighboring or other ECA countries. B y contrast, SDRs from ischaemic heart disease and cerebrovascular disease have increased and are well above that in other parts of Europe. Other indicators such as the incidence of cancer and new HIV infections remain low compared to ECA countries, although the extent to which these are not diagnosedor are underreported is not certain. 18 Box 2.2: Health Status and Trends There are significant differences inhealth status and trends between official administrative data and survey data. For example. the infant mortality rates (IMR) as estimated in three national-level surveys are 2-3 times higher than reported by the MOH. In many cases, the discrepanciesmay be due to under-reporting where registrationi s required for official data (e.g. of births, deaths), or home deliveries of children, as well as definitional differences (e.g. live birth according to the WHO definitions used in the survey may be classified as miscarriages or stillbirths-inthe Uzbek registration system). I ~ .____-~ -. Under 5 Mortality Rate (per 1000 live births) Infant Mortality Rate (per 1000 live births) 100 100 - 80 80 - 64 62 60 60 - I 40 I 20 0 I I 1990 1997 2000 2002 1990 1994 1997 2000 2002 TMD UHES2002 RvlD I UHES2002 I - USh4R MDGTarget for 2015 1s 16 - IMR MDGtarget for 2015 1s 11 - I ~~ - ~~ ~ ~ ~~~ I MaternalMortality Rates (live births,adjusted) Incidence ofTB (per 100000 people) I 100 92 80 I 60 40 20 I 0 1990 1993 19% 2001 1990 1994 1998 2002 TMD TMD DHS 19% UHES2002 +MMR-MDGtargetfor2015~9 - +TB - MDGtarget for 2015 46 1s ~~ ~ ~~ ~ ~~ ~~~ ~ Source: TMD is TransmoneeDatabase, which is basedon official data. UHES - UzbekistanHealthExaminationSurvey, USAID 2002. 2.8 Although data were not availablefor an assessment of public expenditures on maternal and child health programs, the above suggests that efforts be intensified, particularly at the local level. Administering an expanded program of immunizationsand an integratedprogramto address the key causes of childhood morbidity and mortality would contribute to meeting the MDGs. It is also importantto consider an increase in expenditureson public health, particularly at the local level giventhe increasingrates of tuberculosisinfection. 2.9 Public expenditure on health has beenfalling as a share of GDP, as a share of total budget expenditures, in real terms and in per capita terms. Public health spending (including externally-financed) was 2.5 percent of GDP in 2003, decreasing from 3.8 percent in 1995 (Figure 2.1).33 Indeed, current expenditures almost halved as a share of GDP since 1992. Investment in health care has been low, averaging 0.2 percent of GDP in 1995-2003, financed roughly equally by externalloans and domestically (state budget). Extra-budgetaryrevenues, not j3Data on current health expendituresoften includes that of sport while data on investment generally includes sanitary services. Also, data differed dependingon the source but these differences were small. 19 included above, added another 9.6 billion soum in 2002 (0.1 percent of GDP, or 5.5 percent of current expenditure^).^^ Uzbekistan than in neighboring 4 - countries or low income countries but per capita health expenditure is now 2 I less than the low income country 2 average (Table 2.l)? Infact, per capita iE public expenditure on health decreased substantially(even in current soum) and i s now only $8 per year. Official reports , I 0 2.11 Private expenditureson health and the poor. The poor Table 2.1: Health Spending in Selected Countries face many obstacles in Public Private Health expenditure obtaining health care, from expenditure expenditure per capita payingheavily for services to a (%GDP) (Y'GDP) (current US%) lack of transportation to 1997 2001 1997 2001 1997 2001 facilities, as well as Uzbekistan 3.1 2.7 1.2 0.9 27 17 discrimination and a lack of Low Income 1 1.1 3.2 3.3 22 23 transparency in the referral Kyrgyz Rep 1.9 2.1 12 system. The results of the Kazakhstan 2.3 1.9 0.9 1.2 44 44 Living Standards Assessment Russia 4.2 3.7 1.6 1.7 167 115 (World Bank, 2003) showed Poland 4.4 4.6 1.7 1.8 228 289 that a disproportionate burden ECA 4.2 4.3 1.4 1.6 134 123 of the out-of-pocket payments EMU 6.7 6.8 2.4 2.5 1,971 1;857 for health care,fall on the poor. Source: World Development Indicators, 2004 "Informal payments are also significant with more than two-thirds of health users surveyed reportingpayinginformally. The burden of payingfor healthcare has been reportedto affect the decision to seek healthcare in lower income groups in Ferghana36,those with chronic conditions, andpossiblythose ofthe elderly37. 2.12 Government reforms have provided exemptions from paying for medical services, pharmaceuticals, and equipmentfor certain categories of individuals, services, and tjpes of facilities but these may not always reach the poor in need. The population groups entitledto j4 The main source of extra-budgetary revenue is from chargeable services, which is anticipated to increase according to government plans. Sponsor funds (from hakimyats and community organizations) are also important at the local level for the (re-)construction of SVPs. Data were only available for 2001 and 2002. j5 Cross-country studies have shown that public sector health expenditures as a share of GDP are correlated with per capita income. j6 Cashin C (2001) Access to Health Care in Rural Ferghana Oblast, Uzbekistan. Study prepared by Zdrav Plus. Study prepared for USAID; Tashkent. j7 World Bank (2003) Uzbekistan: Living Standards Assessment. Volume 11.Washington DC: The World Bank. 20 free-of-charge hospital services are not necessarily correlated with poverty status (income, employment). Current exemptions also do not fully cover all serious chronic conditions, such as cardiovascular or chronic respiratory diseases which are major causes o f premature mortality in Uzbekistan. As a result, the poor who are not in a category exempt from charges but for whom treatment is neither an emergency nor can be treated on an out-patient basis could have difficulties in accessing hospital care as hospital self-financing i s fully implemented. Moreover, government resolutions and regulations on beneficiaries of free medical care are not tran~parent~~ and evidence from the World Bank's qualitative research indicates that neither physicians nor patients are always aware o f entitlements to free care39.Not all institutions engaged in chargeable service publish a fee schedule and patients cannot fully anticipate the cost o f their care4'. Voluntary health insurance is not yet an alternative as it i s not widely available nor currently accessible to the poor.'l' 2.13 Public expenditures do not I redress inequities. Regions with a higher Figure 2.2: Poorest Regions Get a Smaller I incidence o f poverty spend less per capita Share o f Public Expenditures on Health Care on health care than richer regions (Figure 2.2). Syrdarya for example receives a per capita allocation that i s almost twice that o f Samarkand despite the fact that the incidence o f poverty i s one-third o f Samarkand's. Kashkadarya has one o f the highest incidences o f poverty yet one o f the lowest per capita allocations for health care. This regressive budget allocation probably reflects the fact that current budgeting perpetuates historical patterns o f expenditure, maintaining existing health Sources. Uzbek authorities; LivingStandardsAssessment,World Bank (2003) -~~~ - -pi infrastructure, and not adjusting for population need. Similar variations exist in per capita allocations between rayons Figure 2.3: Distribution of Public Expenditures on In-patient Hospital Visits, within an oblast and oblast administrations by Quintiles and Urban/Rural Areas have limited ability to redistribute 60 revenues from richer to poorer rayons. 2.14 The budget continues tofavor in- - 40 patient care, which benefits the rich and B? urban population more. More than two- P 20 thirds o f the health budget is still spent on hospitals, compared with an average o f 38 percent spent on in-patient care in OECD 0 countries in 2001 (OECD Health Data, 2003). This also perpetuates inequities Sources: Living Standards Assessment, World Bank (2003) I due to the imbalance between health 38 For example, the 1999 Law on Health Protectionprovides for slightly more services than in the 1998 decree while other provisions are vague interms of what shouldbe delivered. 39 World Bank (2003) Uzbekistan: Living StandardsAssessment. Volume 11.Washington DC: The World Bank. 40 World Bank (2003) Uzbekistan:Living StandardsAssessment. Volume 11. Washington DC: The World Bank. 4' Statutory health insurance is unlikely to be a feasible option in Uzbekistanat present as sizeable employeriemployee contributionrates couldfurther increase the informal economy as has been the experience in other CIS countries where it has beenintroduced. . 21 resources consumed by urban and rural populations as rural population seeks care in the first instance in outpatient settings rather than hospitals (57 percent vs. 26 percent) and urban populations seek care in the first instance in polyclinics and hospitals (World Bank, 2003). This general pattern of use o f services by rich and poor is further reinforced by results from a benefit- incidence analysis for hospital services from the household budget survey (Figure 2.3). 2.15 Rationalization and reallocation of expendituresis occurring very slowly. Although the share o f public expenditure allocated to out-patient services has increasedbetween 1995 and 2003 (9 percentage points increase in the State Budget allocation to out-patient services, from 11 percent to 20 percent), only 4 percentage points o f it was due to a reduction in budget to hospitals and 5 percentage points came at the expense of other services i.e. emergency services, - - disinfeciion stations, sanitary and epidemiological stations etc. The limited Figure 2.4: Indicators of HospitalEfficiency reduction in public expenditure on (percentage change, 2003 to 1998) 3 - hospitals i s slowing down the 1 implementation o f government priorities -1 on more cost-effective primary and -3 I outpatient health care. In fact, patient e$a -7 -5 admissions, bed numbers, and average -9 length o f stay (ALOS) in hospitals -11 decreased by 13-15 percent and the -13 -15 number o f hospitals reduced by over 9 Hospitals MAdmissions per 1000 population* percent, but hospital staff numbers OBeds per 1000 population* 0Average length ofstay* overall decreased by only 2 percent Hospital physicians including a small increase in doctors (see _*_ZOO1 ___ to 1997. BMid-level, junior and gtcr hospitalstaff ~ Figure 2.4). Source Ministry of Health, 2004IMmistry of Statistics, 2001 2.16 A disproportionate number of staff remain in hospitals (62percent of doctors and 70 percent of total health staffi as compared to out-patient settings. Although staff in the out- patient setting increased by 19 percent between 1998 and 2003, there was an overall net staff increase inthe health sector, as hospital staff did not decline much. 2.17 The high share of salaries in the budget is squeezing out other recurrent expenditures, such as equipment and pharmaceuticals. Uzbekistan spent 60 percent o f total expenditures on staff but only 10 percent on drugs in 2001 while Germany spent 49 percent to 16 percent respectively and in Canada it was 25 percent to 16 percent.42 Moreover, although approximately 10 percent o f the budget for hospitals i s to cover pharmaceuticals, in practice the actual expenditure is often much less, partly because utility payments (in the same budget line, namely, category 4) take precedence for payment before pharmaceuticals are purchased. Dori-dormon, the quasi-public pharmaceutical distributor, reportedly accounted for 40 to 70 percent or even higher o f drug supplies to hospitals.43 While Dori-dormon has been important in sustaining a quality supply o f drugs to health facilities, this i s not the most efficient way to ensure supply or best prices for drugs in health facilities. In fact, a study o f retail prices for selected drugs in Ferghana found them to be 64 percent - 494 percent above median international prices. 44 As 42Data on expenditureson staff as apercentage oftotal expenditures is not always accessible in other countries because of out-sourcing and the structure ofthe delivery system. 43Dori-dormon offers hospitals the opportunity to purchase drugs on credit which, in effect, adds an unofficial stream of funds for Republican facilities as the MoH will cover money owed to Dori-dormon. In 2003, the MoH paid an additional 157 million soum for drugs in this way. 44Nurgozhin T. Pavin M, Hafner G. Yusupov F. Khusanbaev S and Laing R. (2001) The Pharmaceutical Study in FerghanaOblast, Uzbekistan. Technical Report preparedfor USAIDby ABT Associates Inc. 22 payment for drugs accounted for 50 percent-90 percent o f out-of-pocket expenditures on health care, the cost o f drugs i s a significant burden particularly to the poor4'. 2.18 Whileprogress has been made in establishingSVPs, currentfunding levels are uneven and inadequate to ensure afully functional primary care network. An inventory o f SVPs across oblasts found that a number o f SVPs lacked basic infrastructure including water, sewage, telephone line, heating and e l e ~ t r i c i t y . ~Further, anecdotal evidence from the pilot regions ~ indicates that many must operate with frequent power outages and some report less than one hour o f power per day. As a result, many pieces o f equipment could not be used effectively. Variations in funding exist across rayons due to lack o f pooling at the regional level. For example, in 2003 there were significant differences in per capita health spending between rayons, that varied from 2000 to 5500 soums in Tashkent and from 3000 to 5000 soums in Andijan for in- patient facilities. For out-patient facilities these variances are from 700 to 3000 soums and from 600 to 1500 soums in Tashkent and Andijan respectively. Although additional funding for primary care was envisaged through the closure o f outpatient and excess hospital capacity, hospital rationalization did not take place to the extent envisaged, and savings were diverted to buildingand equipping o femergency hospitals. This consequently compromised some aspects o f service delivery in SVPs (Box 2.3). Box 2.3: Challenges o fRationalizationunderthe World Bank's Health IProject Need to be Addressed I Under Health Irationalization plans for hospital infrastructure inthe three pilot oblasts. savings were envisaged from the closure of excess hospital capacity that could be redistributed to primary care. Although bed closures were reportedin each of the three oblasts, the number of buildings or associated staff were not similarly adjusted such that the net financial benefit to the primary care sector was small. Staff costs as a share of total healthexpenditureactually increased. There remain a large number of duplicative specialty hospitals, excess beds. large numbers of poorly paid staff. older or inappropriate physical infrastructure and relatively long lengths of stay. New rationalizationplans were proposed in each oblast inlate 2003. Important barriersto rationalization persist: o Financial incentives are based on bed and staff numbers acting as a disincentive to rationalization o Staff have a vested interest not to see closure or any streamlining of their numbers. o Administrative boundariesmean rayons attempt to maintainlocal facilities even ifduplicative with neighboring rayon. o Legal framework is in some cases inconsistent andpractical guidelines are lacking. o Clinical services are not evidence based. vertically delivered and do not necessarily address population health needs. Source Consultant report for the World Bank's Health I1projectprepared by John Snow Inc ,2004 2.19 Without an adequate supply of priority drugs and related supplies, the SVPs cannot operate effectively, and this is an important determinant of wherepatients decide to seek care. Ifpatients choose self-care from a privatepharmacy or seek treatment at a hospital; these options may not be cost-effective for the health care system in the long run. Despite these caveats about the remaining challenges for SVPs, the pilot regions o f Syrdarya, Navoi, and Ferghana have demonstrated improved allocations relative to hospitals, and have shown an increase innumber o f visits to SVPs relative to other regions, along with decreases in the number o f patients treated in hospitals. `jWorld Bank (2003) Uzbekistan: Living StandardsAssessment. Volume 11. Washington DC: The World Bank. 46Health Facility Survey (2004) undertakento evaluate SVPs financed under the World Bank`s Health Iproject. 23 D. RECOMMENDATIONS OPTIONS FORREFININGHEALTH AND POLICY AND IMPROVING THE EFFICIENCYAND EQUITY OFEXPENDITURES 2.20 Overall, public spending in the health sector should be realigned from historical patterns to better meetpopulation health needs and governmentpriority areas. Public spending on hospitals could be decreased from current levels and re-directed towards the development o f more cost-effective primary care, emergency aid, maternal and child health and other priority areas. Some savings have already been achieved, but more are possible. This would also be important in achieving MDGtargets. Expenditure reallocation could be facilitated by eliminating the current input-based budget system, then accelerating the change in regional allocation formulas, and establishing regional pooling o f funds (short-term) and performance-based hospital payment mechanisms (medium term). Cost-effective primary and outpatient care can be expanded to treat chronic conditions and some surgeries on an out-patient basis over the medium- term (longer-term). Desired .realignment o f allocations would follow increased use o f primary care, but would depend upon the pace o f hospital rationalization. D.l Short-Term(Within 1Year) 2.21 Pool and manage healthfunds at the oblast level. The regional per capita allocations should be pooled with any local and district contributions, and funds managed at the oblast level. The model would replicate the experience in the primary care pilot regions but could be extended to cover all areas o f health care expenditure. This would enable a larger risk pool to facilitate planning and purchasing functions at the regional level. Both contracting and payment arrangements could stimulate competition and improve allocative and technical efficiency. It could help redress the financing imbalance between the urban and rural areas. It could further facilitate reallocation to priority services such as primary care. Box 2.4 sets out steps taken under the World Bank's Health Iproject to pool resources at the regional level. The process is rolled out countrywide under the World Bank's Health I1project and can be scaled up to include the entire mix o f regional funds. Box 2.4: Seven Steps to Oblast Poolingand Per Capita Financing: An Exampleof Rural Primary Health Care (PHC) Budgets Approval of legal and normative documents on oblast pooling of budgets as well as of allocation models such as per capita financing of rural PHC facilities at the republican (Cabinet of MinistersiMinistry of Health) and local (oblastirayon hokimiyats and oblastirayon Health Departments) levels. Analysis of historical trends in actual budget expenditure on facilities over the past 2-3 years in the oblast. by rayons and cities. Transfer of the rayon and municipal health budgets to the oblast Finance Department. Decision on the relative share of the oblast health budget to be spent on each level of facility in the coming year, depending on the correspondinghistorical public expenditure trends. This is primarily a policy decision, but the resulting allocation should not be less than previousyear's actual expenditure. The shares can be adjusted later based on performance criteria. Determinationof the unified, oblast-wide per capita financing rates for various types of facilities. For rural PHC, for example, per capita financing rate can be calculated by dividing the total allocation made for rural PHC by number of population living in the catchment areas of the rural PHC facilities. The oblasts should be able to pool and allocate budgets for other levels according to similar formulas. Allocation of funds for each facility level. For example. for rural PHC facility/SVP the pool is determined on the basis of corresponding catchmentienrolled population data, adjusted for sex, age and populationdensity. Budgets for the year for each PHC facility are obtained by multiplying the adjusted per capita rate by the population for each PHC facilityiSVP. Specified formulas determine budgets for other levels of facilities. 24 2.22 Improve management of the pharmaceuticals supply. To ensure that health facilities obtain their drug supplies through reliable sources and at competitive prices, the Government could consider the possibility o f expanding competitive bulk tenders for supply o f multi-sourced drugs inhospitals. 2.23 Formalize informal payments. Informal payments could be tackled by formalizing and making transparent fees or other co-payments. This has been the case in the Kyrgyz Republic where reforms in four oblasts resulted in a decrease in the amount o f informal payments, lower total spending by the patient, improved targeting o f benefits to persons in exempt categories and reduced patient uncertainty about their financial obligation for hospitalization. Overall, patients need to be better informed o ftheir rightsto free benefits, and have effective legal redress; a media campaign could be an effective tool as a first step. 2.24 Change the central-to-regional allocationformula. Re-allocating funds for health at the national level across regions would allow for redistribution from rich to poorer regions and from healthy to sick populations so as to improve geographic equity. A Presidential decree adopted in 199S4' allows for budget allocation based on the population principle. The implementation o fthis decree should be accelerated so that health funding to oblasts could be allocated on a capitated basis with adjustments made for patient characteristics including demographic, epidemiological, socio-economic and I Figure 2.5: Regional Allocations Currently versus Per Capita with Adiusters other relevant factors. Figure 2.5 simulates an example o f a capitated regional allocation adjusted for infant mortality, sex and age o f the population. Further refinement could include adjustments for the cost o f delivering care in more remote areas with other important risk adjusters added over time. The formula itself is straightforward, but must be integrated with a broader system o f intergovernmental fiscal transfers, probably necessitating some initial period Source: Uzbek authorities, LSA, World Bank staRcalculationr. o f study and phased implementation. D.2 Medium-Term (1-3 Years) 2.25 Improve allocative efficiency through performance-related payment to primary care providers. Rural primary care facilities in pilot regions now receive payment on a per capita basis, with flexibility for generating savings which can be reallocated for pharmaceuticals and equipment. These rural SVP per capita pilots in five regions should be extended to the remaining regions. New urban primary models - which extend per capita financing to urban primary care practices -- should begin as envisaged under the World Bank Health I1 project. Early results suggest increased allocations for primary care, increased visits and utilization at the primary care levels, and fewer referrals to more expensive specialists and hospitals. More funds were spent on pharmaceuticals. There was improved equity o f funding across rayons. Quality improved through improved levels o f equipment and supplies, and national training programs for physicians and nurses. 47Presidential Decree UP-2107 ofNovember 1998. 25 2.26 Improve technical efficiency throughperformance-related payment to hospitals. Gains in efficiency could be made by replacing input-based budgetingwith payment mechanisms at the hospital level that reward higher throughput while motivating a decrease in cost-per-case; performance-based payment i s best applied within a global budget as has been the experience in other countries (see Box 2.5). Decreases in the cost-per-case could result from lowering the average length o f stay and staffing levels and could result in overall cost savings if combined with a global budget. The case-based performance payment mechanism is currently being piloted in two hospitals in Ferghana with plans for wider roll-out under the proposed loans of the World Bank and Asian Development Bank. Box 2.5: Rewarding Hospital Providers: Lessons from the Performance-Based Approach in Transition Countries The need to decentralize management, improve efficiency and contain costs in the health care system has encouraged the move away from line item budgeting towards performance-based payment mechanisms for inpatient care in many transition countries. Subsequently, payment systems became activity based. Payment was based on measurable units of hospital outputs in the early stages of transition and included per diem and "simple" per case payment not adjusted for patient severity. These models required little data and were relatively easy to implement. Providers responded to these incentives by decreasing the average length of stay. However, any savings to payers were offset by increases inthe volume of cases admitted (e.g. Croatia, Czech Republic, Hungary, Russian Federation) especially easy cases that were less costly. In response many countries are now adjusting levels of payment relative to severity, or combining payment for activity with volume controls. Models include: facility adjusters which adjust the level of payment for categories of facilities as a proxy for overall case severity (e.g. Croatia, Hungary, Kazakhstan,Latvia, Slovakia, Russian Federation); outlier payment features by paying a higher rate for statistical outlier cases as measured by standard deviation from the mean for measures such as costs or length of stay (e.g. Lithuania, Hungary); global budgets to cap hospital expenditures with case-basedpayment (e.g. Albania, Armenia, Czech Republic, Estonia, Hungary, Lithuania, Romania, Slovenia, Slovakia, Poland, Russian Federation). Source: Lanaenbrunner et al.. 2004 _ _ _ ~ ~ - ~ ~ - . 2.21 Facility rationalization and human resource planning. N e w incentives should be coupled with a well-defined strategy for merger o f old Soviet model vertical-system health facilities. Much o f the specialized care can be integrated into general care hospitals. The development o f rationalization plans at the oblast level, coupled with budgets based on population and not inputs, would allow for greater flexibility and improve quality and efficiency. Rationalization should be coupled with creation o f incentives to motivate change at the facility level. Finally, the oblasts should be allowed to retain some or all o f savings, to motivate further rationalization. Excellent oblast level rationalization plans have been developed in Ferghana and Syrdarya already, but there i s no incentive to proceed as long as budgets are tied to inputs. 2.28 I n line with delivery rationalization, a compatible human resource strategy should be developed that not only considers staff numbers (people and slots), but also emerging needs according to the types of facilities and location. Staff attrition through retirement and redeployment is, of course, likely to cost less than redundancy packages but would be a slower process. The strategy could also address salary levels and ways o f formally increasing base-rates. To improve rural staffing both the adoption o f physician bonuses to relocate to rural areas as well as the reintroduction o f the quota system in physician education to increase enrollment from rural areas could help to increase physician numbers in rural settings. In June 2004 the President established a task force to re-allocate savings from health sector rationalization to providers, and to develop an improved system o f remuneration that is more performance-based and hopefully will redress the current imbalances across rural and urban settings, and geographic areas. 26 2.29 Enhancing management autonomy to improve efficiency. If efficiency gains are to be made at the facility level, managerial autonomy is necessary to use funds in a way that addresses needs. Increased autonomy over purchasing, personnel management and service provision means greater accountability by the hospital for its own institutional decisions. Good models that combine autonomy and rationalization are emerging in Estonia and Poland (see B o x 2.6) and other countries in Eastern Europe. This could be accomplished, over the medium term, through a liftingof restrictions on moving funds between line-items, accompanied by training and guidance on ways to improve managerial decision-making. Budget allocations should not be reduced if savings were made in the previous year. A recent Presidential Decree4*provides for some first steps towards financial flexibility and autonomy of republican specialty hospitals. Box 2.6: Combining Autonomy, Rationalization, and Incentives: Emergent Lessons in Transition Countries Rationalization of health facilities, beds and staffing can occur through (i)centrally planned and implemented downsizing; or (ii)market driven downsizing resulting from incentive motivating autonomous entities (single health facilities: networks etc.). In successful cases some combinationof the two are adopted as can be seen below. Estonia: Devolution of managementto autonomous networks: Strategy focused on facility optimization rather than bed optimization through mergersthat networked duplicative hospitals and policlinics in the same geographic area into a single managemententity (network). Network managersgiven the autonomy to close facilities: layoff staff as well as manage beds and other resources as needed in their network. Facility level release and stepwise re-recruitment under new contracts with performance related salary system Strengthened purchasing function through poolingin regional funds: Networks contract with 4 regional funds where resources are pooled and services are purchased. Performance-based payment introduced for networks: Contracts to networks determined on aper case basis within a global budget. Masterplan developed to guide developmentof networks and targets for downsizing: A hospital masterplan was adopted in 1999with the goal of reducingthe number of acute hospitals from 78 to 13 including: 2 regional tertiary care centers with a catchmentpopulation of 600,000 and 800;OOO; 5 central hospitals with catchment populations of 100,000-150,000; and 9 county hospitals with catchment populations of 30,000-50,000. Results: reductions in hospitals, beds and average length of stay Poland Devolution of managementto autonomous hospitals: Through the program, hospital ownership was transferred to local governmentsand then made autonomousso hospital managershad the right to manage their own resources (closing beds: hiring or firing staff). Masterplan:A masterplanwas also developedto assess whether and were there was excess capacity particularly interms of beds and staff. Matching staff numbers to full time equivalent positions. There were, infact, more full-time equivalent positions than staff and many staff were found to hold multiple positions. Full-time equivalent positions were subsequently reducedto match them to the number of staff. Results: reductions in both bedand staff numbers Georgia HospitalRestructuring Masterplan: A masterplanwas developed for the closure and privatization of redundantand excess health facilities. Plan implemented by a special government agency Agency found it politically difficult to close hospitals and instead merged facilities into common entities. N o market forces or incentives used to actually drive facility closures and optimization. Results: on paper there are fewer hospitals because merged facilities now defined as a common unit, however, in reality very few hospitals have actually been closed. 48 Presidential Decree UP-3214 of February 2003 27 2.30 Open enrollment in primary care. A possible way to improve service quality and introduce market principles at the primary care level would be to allow open enrollment or the choice o f primary care provider. Patients select the primary care provider during an announced period o f (for example) one month every year. They register and money accordingly follows the patients. Patients have more choice; physicians then compete for patients at the primary care level. This i s better done inurban and densely populated rural areas. It will be piloted in up to 28 districts under proposed World Bank Health I1project. 2.31 Strengthening the referral system The transparency o f the referral system could be strengthened now through a review o f the guidelines for referrals and current legal framework as well as a media campaign informing o f their rights and entitlements. Inthe medium to long-term, further incentives can be introduced to motivate patient and provider behavior. For patients without a referral from a primary care doctor, their hospital care may not be free or subject to higher charges for the same services. D.3 Longer-Term (3-5 Years) 2.32 Expand thescope of primary and outpatient care. Cost-effective primary and outpatient care can be expanded to treat chronic conditions and some surgeries on an out-patient basis over the longer-term. Western European countries allocate less than 40 percent o f expenditures for in- patient care - it i s nearly double that number today in Uzbekistan. Even Uzbek physicians estimate up to 30 percent o f in-patient admissions can be moved to less expensive outpatient care and day surgeries. This will require completion o f the SVP building and the expansion o f the national General Practice training program, and developing dedicated outpatient surgeries in existing health facilities. Treatment protocols are currently out o f date, in some cases more than two decades, due to the lack o f evidence-based information restricted during Soviet years. New protocols will needto be taught or provided through retraining programs. 28 CHAPTER 3. EDUCATION A. INTRODUCTION 3.1 A widespread problem in the former Soviet Union - and in Central Asia in particular - has been the declining quality o f education resulting from collapsing output and severe budgetary contraction since the start o f the t r a n ~ i t i o n . ~In~ this setting, Uzbekistan stands out for the extraordinary effort it has made to maintain education expenditures. In the mid-l990s, Uzbekistan devoted a higher percentage of its GDP and state budget to education than any other country in the region - indeed, even higher than in any OECD country. Since then, the share o f GDP and state budget devoted to education in Uzbekistan has risen further. About 9 percent o f GDP i s spent on education institutions (including from extra-budgetary sources). This proportion is expected to rise to 11 percent under the major new initiative in basic education which was launched in May, 2004. H o w are these funds being spent in the education sector? I s the education which is being supported relevant to the needs o f the economy? I s it leading to higher incomes, higher rates o f employment, and lower incidence o f poverty5' than in neighboring countries? This chapter attempts to answer these questions. B. CHALLENGES 3.2 Uzbekistanfaces a number of challenges in developing its education strategy. There are an estimated 350,000 new entrants to the labor force each year. These new labor-market entrants are the main instrument for reconfiguring the skill endowment o f the labor force to respond to the new requirements o f the evolving economy. They constitute both an opportunity (to anticipate and meet these needs), and a risk (of risingunemployment ifthe skills they bring to the labor force are not what the economy needs, and if supportive macro-economic policies to encourage job creation are not in place). 3.3 Demographic developments have important implications for budget needs in the education sector during the rest of this decade. Fertility in Uzbekistan fell early Figure 3.1: Projected Growth of School-Age in the transition, but has not continued to Cohorts, 2000-2025 (million persons) fall as it has elsewhere. The rate o f 1.7 - natural increase remains positive - it is currently estimated at 1.4 percent per year -- and is second only to Turkmenistan 1.5 +5-9 years among the CIS countries. One o f the 1.4 *10-14 years consequences o f this relatively high rate 15-19 years o f natural increase is the country's very 1.3 20-24 years ~~~ young age structure: 41 percent o f the 1.2 -- population is under 19 years o f age. But I 1.1 ~ the recent fertility decline means that 2000 2005 2010 2015 2020 2025 there will be sharp fluctuations in the size Source: World Bank projection, based on demographic parameters o f specific school-age cohorts for at least updatedin September, 2003. 49See, for example, MartinGodfrey, .`Quality of Learning: Towards Unilateral Disarmament?" in Social Monitor 2002: Social Trends in Transition, HIVIAIDS and Young People, Quality of Learning in Schools. UNICEF Innocenti ReserrcheCentre, Florence, Italy; 200: and Michael Mertaugh, "Education in Central Asia. with Particular Reference to the Kyrgyz Republic", in The Challenges of Education in CentralAsia, edited by StephenP. Heyneman and Alan J. De Young, InformationAge Publishing, 2003. 50The links between education and poverty in Uzbekistan are described in Chapter 6 of Uzbekistan Living Standards Assessment: Policies to Improve Living Standards, World Bank Report No. 25923-UZ, May 2003. 29 the next two decades. As shown in Figure 3.1, the size o f the 5-9 year cohort will shrink quite sharply for the first decade o f the century, then will grow gradually thereafter. The size o f the IO- 14 year cohort will follow a similar pattern, with a slight lag. In marked contrast to this pattern, the sizes o f the 15-19 year cohort and 20-24 year cohort will increase sharply over the next 5-10 years, and then shrink gradually in subsequent years. In view o f the major reform o f secondary education which is currently under implementation, it is particularly important that these implications o f changing cohort size be reflected in the Government's education strategy and budget planning (discussed below). 3.4 Past budget erosion has weakenedbasic education. Real expenditures for education fell early in the transition, and have only recovered to pre-transition levels during the past four years. Real teachers' salaries were progressively eroded. Starting school teachers currently earn less than two-thirds o f the average monthly wage in the economy. Expenditures for other vital educational activities - including in-service teacher training, educational materials, and other inputsto maintain and update teaching and learningmaterials -- have been reduced to alarmingly low levels. As a result, the quality o f education and the condition o f schools has deteriorated in all communities except the few that were able to supplement budget financing for schools through local sources. 3.5 Efficiency of used education resources is low. As education budgets contracted, the response o f managers throughout the system focused on maintaining the jobs o f teachers and other educational staff. Teacher student ratios rose and teacher workloads fell significantly at all levels o f the education system, signaling declining efficiency o f provision, and salary expenditures rose as a share o f recurrent expenditures - currently accounting for more than 77 percent o f recurrent expenditures in general education. 3.6 Enrollments contracted during the transition. As in other transition countries, enrollments in preschool fell sharply (by more than half) as many o f the preschools that had been supported by enterprises and communities closed for lack o f financing. But most strikingly, enrollments in higher education fell by 50 percent in the first half o f the 1990s, in contrast to other transition countries where they grew significantly. Although they began to recover in the late 1990s, higher education enrollments in Uzbekistan are still below their pre-independence level. Unlike the pattern in other transition countries, where access to higher education has become more egalitarian, in Uzbekistan it has become even more exclusive than it was during the Soviet period. Access to higher education in Uzbekistan is strongly skewed in favor o f higher- income groups (see below). C. GOVERNMENT POLICYRESPONSE C.l. Changes in Financingof Education 3.7 Recognizing these challenges, the Governmentadopted a number of measures early in the transition to reduce budget expenditure needs and diversify sources of financing. Education financing was diversified by: 0 decentralizing the responsibility for financing and managing most primary and secondary education programs from central to oblast governments, 0 requiring parents to purchase textbooks which had formerly been provided by the Ministry o f Public Education (except for grade I,where they are still provided free) 30 0 instituting a program o f cost recovery through contracted (fee-based) provision o f specialized secondary and higher education within public schools and universities for students with entry scores below the threshold for budget-financed admi~sion,~' 0 introducing rental-based provision of textbooks, and 0 allowing schools to supplement budgetary income through parental and community contributions and through actions such as rental or sale o f unneeded facilities and provision of paid extracurricular courses. C.2. Changes in the Structureof Education 3.8 The centerpiece of the Government's education reform is the National Program for Personnel Training (NPPT). This program, which was launched inAugust, 1997, fundamentally restructures secondary and higher education with the intention o f providing new skills required in the global economy.52 At the same time, it aims to raise the skill levels o f future labor-market entrants by extending the duration o f compulsory education from nine years to twelve years. The program i s extremely ambitious, with few precedents in recent history.53 Under the NPPT, a new program o f three-year academic lycea is replacing the current two-year program for secondary general education. The new academic lycea are attached to universities and staffed by university faculty. In parallel with this, the country-wide network o fprofessional technical schools (PTUs) and vocational secondary teknikums is being transformed into a new network o f three-year professional colleges at the secondary level, with close links to enterprises and flexible curricula which are intended to respond to local employment needs, while also enabling graduates to progress to higher education. When the program i s complete, 90 percent of secondary enrollments are expected to be in these newprofessional colleges. A total o f 300 academic Iycea and 1,700 professional colleges are envisioned for the program, with total enrollments o f 1.5 million students. At the same time, higher education programs are being regrouped under an Anglo-Saxon model o f bachelor and masters degree programs, with an expansion o f programs in computer sciences, business administration and economics, other social sciences, and English language. When the NPPT program i s fully inplace, it i s expected that that virtually all graduates o f the academic lycea will go on to university. Graduates o f theprofessional colleges will also be eligible to go on to university if accepted, although few are expected to do so. The target date for full implementation of the program has been delayed from September 2004 to September, 2009. Currently, the program is slightly under 50 percent completed. About 230,000 o f the 500,000 students completing grade nine each year enter academic lycea or professional colleges. Most, but not all o f the rest continue their studies in as-yet unconverted two-year professional technical schools. Some students still do not continue their studies after completion o f grade 9. 3.9 The enrollment goals of the NPPT have not yet been met. Although compulsory education was extended from 9 to 12 years under the NPPT, upper secondary enrollments actually declined slightly since the start o f the NPPT in 1998. Since the size o f that age cohort increased, actual coverage o f secondary education has fallen significantly during the early years o f implementation o f the NPPT from 75 percent o f the age group in 1999/2000to 61.4 percent in 2002/03, with a consequent estimated enrollment gap o f more than 700,000. Actual rates o f school attendance are lower still. The sample-based household survey data reported that, on 5 'Currently. 40 percent of university entrants are budget financed. Fee levels for the "contract" students average from 300.000 to 400,000 soums. and are meantto provide full cost recovery. There are no private universities. j2 Shavkat Kurbanov and Edem Seitkhalilov. National Program for Personnel Training: the Basis for the Achievement of Strategic Goals. UNESCO, September. 2000. j3 One is the Turkish Government's decision. enacted the same month as the NPPT, to extend the duration of compulsory education from five years to eight years. Implementation of this change involves a multi-billion-dollar. decade-longprogram to build, equip, and staff new eight-year basic education schools. 31 average, only 36 percent o f the age group was attending school. For the lowest income group in the survey, the survey reported an attendance rate o f just 27 percent for the 16-18 year cohort. The feasibility o f attaining universal 12 year education i s questionable when many families are struggling with very low incomes (both because o f the opportunity cost o f the child attending school as well as the direct cost o f textbooks and other educational purchases.) To reduce the costs o f school attendance, the Government has adopted a textbook rental scheme which reduces textbook costs. It has also expanded its social support programs to exempt low-income students from textbook rental or purchase, and to provide free clothing and educational materials to low- income students. These actions taken by the Government to reduce the costs o f school attendance are commendable. But further actions (such as school meal programs in low-income areas) are likely to be needed to attain the goal o f 100 percent secondary coverage. At the same time, the very high costs o f the new schools under the NPPT imply that adjustments may need to be made in the design o f the program - such as retaining and expanding general upper secondary schools o f the earlier format - in order to keep costs to sustainable levels. 3.10 The Government's new Basic Education Program is intended to raise the quality of education at the base of the educationalpyramid, thereby raising the effectiveness of secondary and higher education, and improving employment prospects and productivity. The program was created by Presidential decree in May, 2004, and comprises a major program o f school rehabilitation and construction, provision o f educational materials and equipment (including IT and internet access), and training o f teachers and school principals. Accompanying the major investments under the program are significant salary increases for teachers and school principals, some o f which are performance-based. Salary increases adopted since the start o f the program reportedly average over 50 percent. These very significant increases reverse the long-term trend o f declining real salaries in the sector. They are also expected to help restore prestige in the teaching profession and to attract qualified graduates to become teachers. The investment costs o f the program are estimated at $1.2 billion over the projected 2004-2009 implementation period. The program i s to be financed by a combination o f donor financing and budget financing, the central feature o f which is a new earmarked sales tax o f 1 percent. This new tax is expected to generate additional revenues o f from 150 to 170 billion soums per year. Donor financing o f about $82 million has also been pledged in support o f the program, and more is being sought. D. EDUCATIONEXPENDITURES D.l. PrivateExpendituresfor Education 3.11 The explanationfor declining enrollment and attendance rests largely on the increased private costs of education, including informal fees. The average education-related expenditure per student in basic education in 2000 was more than the poverty level monthly expenditure on food. The Government is trying to alleviate the burden by providing targeted subsidies for free educational materials and winter clothes for the poorest students in grades 1 through 4, up to a maximum o f 15 percent o f students inthose grades. Starting with the 2003/2004 school year, the Government has issued instructions to provide free textbooks to all low-income students. For secondary and higher education, household outlays are much higher than for basic education. About 60 percent o f the students in higher education are "contract" students. The average tuition fee for these students is about 300,000 soums per year, although about 40 percent o f the fee i s returned to the student as a stipend. Students from poor households are eligible for a 50 percent reduction o f interest charges on the loans. But since the average annual wage i s about 350,000 soums, it i s still not within the reach o f poor households. Even the household survey showed that children o f households in the highest income quintile are six times as likely to attend university as children o fthe lowest income quintile household. 32 D.2. PublicExpendituresonEducation 3.12 Although Uzbekistan spends a high percentage of GDP and public expenditures on education (Table 3.1), it has been spending too little on basic education, and a disproportionately high amount for secondary and higher education. Public expenditures on education fell in the first half o f the 1990s - as a share o f GDP and even more in real terms -- but have been rising since then and are closer to their total level at the time o f independence (see Table 3.2). However, the composition o f Table 3.1: Public Expenditure on Education compared expenditures has changed. Recurrent with OECD expenditures continued to decline, falling Country As ('YO)of GDP As (%) of expenditures in the early 2000s compared with the Uzbekistan 8.4 22 second half o f the 1990's (on average by OECD average 5.1 13 0.7 percentage points o f GDP). But the Source: Uzbek authorities and staff calculations. OECD data increase in investment expenditures from from Education at a Glance, 2001. 1999 more than offset the decline in recurrent expenditures. Overall, budget growth has been concentrated in the new programs o f upper secondary education, where the development o f the new-format professional colleges and academic lycea under the NPPT has drawn resources away from general education in grades 1-11. As a result, teaching and learning conditions in primary and lower secondary education have fallen - in some cases, to unacceptably low levels. As shown in Table 3.2, per-student recurrent costs o f specialized Table 3.2: Public Expenditure on Education secondary education are three times State budget Foreign- Total public as high as for general education in Recurrent investment financed' expenditure grades 1-11; per-student total costs o f specialized secondary education 1995 7.4 0.4 0.0 7.8 are more than eleven times as high 1996 7.4 0.1 0.0 7.5 as for general education in grades 1997 7.1 0.3 0.0 7.4 1-11. How does this compare with 1998 7.6 0.3 0.0 7.9 spending levels in other countries? 1999 7.5 1.8 0.0 9.3 Uzbekistan spends more than five 2000 6.7 2.5 0.1 9.4 times as much (expressed as a share 2001 6.8 1.o 0.3 8.1 o f GDP) for each student in 2002 6.7 1.9 0.2 8.8 specialized secondary education as 2003 6.5 1.8 0.2 8.4 the OECD average for upper ' Convertedatthe official exchange rate. secondary education, and almost Source: Uzbek authorities and World Bank staff calculations three times as much as the OECD average for higher education. On the other hand, it spends one- third less than the OECD average share o f GDP for each student in general education, and less than half as much for each student in grades 1through 4 (Table 3.3). These figures document the serious budgetary neglect o f basic education under past resource allocation - a problem which is addressed under the Government's new Basic EducationProgram. 3.13 Although totalpublic expenditures are high in Uzbekistan, acutefunding shortages of education persist. That is because the decline in recurrent expenditures was largely in general secondary (grades 1-11) education (especially in the crucial recurrent budget category for educational materials) the most (where public expenditures fell from 4 percent of GDP to 3.6 percent o f GDP between 1997 and 2003) and also hit the old-format vocational schools (PTUs and technicums) which later also faced a sharp cut in student stipends. Indeed, the unit costs o f education (scaled by per capita GDP) are much higher in Uzbekistan than in OECD countries, exceptfor basic education (primary and lower secondary, see Table 3.3). That is, expenditures per student, expressed as a share o f per capita GDP, are lower in Uzbekistan than in most o f the comparator countries for basic education, but they are almost twice as high for preschool and 33 three times as high for higher education. But it is at the upper secondary level that the differences are most striking,where Uzbekistan i s spendingmore than six times the OECD norm. Table 3.3: Per-Student Budget Costs of Education by Level, 2002 Preschool General Specialized Higher education education. secondary education grades 1-11 education 2002103 Enrollments 631,146 6.286,782 466,786 90.913 2002 state budget expenditures(UZS mil) Recurrent 86,484.2 264,591.5 59.278.2 31,281.1 Investment 1,674.3 6,486.2 168,214.1 2,050.4 Total 88,158.5 271,077.7 227,494.3 33,331.5 Unit cost (UZS) Recurrent 137,027 42.087 126.992 344,077 total 139.680 43,119 487,363 366.63 1 Total as percent of per capita GDP Uzbekistan 47.4 14.6 165.4 124.4 OECD average 18 21 29 44 Source: Enrollments provided by the Council of Ministers. Higher education enrollments are budget students only. since the expenditure figure excludes fee-financed expenditures. Investment expenditures for specialized secondary include NPPT investments of UZS 166,628 billion. Unit cost as percent of 2002 GDP per capita calculated on the basisof the following World Bank estimates:UZS 7,469,347 mil/ 25.352 million = UZS 294,626. 3.14 The main reasonfor higher per-student recurrent costs in Uzbekistan is small average class size in preschool education, lower secondary education (grades 5 through 9) and, especially, upper secondary education, as reflected in studenuteacher ratios. Average studendteacher ratios for the PTUs (5.0), and academic lycea (6.5) are less than one-half the OECD average (14.1) (Table 3.4). Prior to2001, they were also very low for the new professional colleges (6.5), but have since increased as professional college enrollments increased six-fold in just two years (in part, through conversion and Table 3.4: StudentlTeacher Ratios by Level of Education re-labeling o f many o f Studentheacherratios the old-format Country - . . Preschool - . Primary Lower Upper Higher professional schools). secondary secondary In contrast, the average Uzbekistan 11.0 18.0 13.0 15.0 12.0 studendteacher ratios for South Korea 23.9 32.2 21.9 22.5 NA grades 1 through 4 United Kingdom 16.5 22.5 17.4 12.4 18.5 (21.3) i s well above the United States 19.3 16.3 16.8 14.5 14.0 OECD average (I8.'). OECD average 15.4 18.0 15.2 14.1 15.3 There i s scope for Source: OECD datafrom Education at a Glance, 2001; rationalizing and improving efficiency where studentheacher rations are low, but part o f the "savings" from this action should be used to improve teacher motivation (and learning achievement) through higher teacher salaries. But the relatively low costs in primary and lower secondary education in Uzbekistan also reflect the virtual absence o f investments and non-salary inputs (which have been squeezed out for basic education). Highercosts for upper secondary and higher education also reflect outlays for student stipends, and better provision o f supporting educational inputs o f all kinds than in general education. 3.15 For upper secondary education, costs areparticularly highfor several reasons: Expanded secondaly coverage. The increased number o f students resulting from the extension o f compulsory education from 9 years to 12 years i s estimated at between 600,000 and 700,000. 34 Increased share of vocational education. The NPPT proposes to allocate twice as high a proportion (90 percent) o f secondary students to vocational education as the proportion (45 percent) at the start o f the program. The unit costs of vocational secondary education are more than 10times as high asfor general secondary education. The unprecedented large investment costs of NPPT. Although these are not expected to continue beyond the current decade, they are much higher than the costs for conventional schooling. For example, the average cost o f buildingand equipping a single classroom in the Japanese-financed agricultural professional colleges is $1% to $2 million. Although the investment costs o f the academic lycea are less than this amount, they are still substantially above the cost o f replicating the existing secondary general schools. The NPPT creates redundant capacity in some existing secondary schools, thus necessitatingconstruction of new schools which would not otherwise be necessaiy. e Higher recurrent costs. The per-student recurrent costs o f the new NPPT secondary schools have been between 50 percent and 300 percent higher than for the former secondary schools. Students in the PTUs and technicums received stipends which, in the aggregate, amounted to more than one-third o f total outlays for teachers' salaries. These stipends are being phased out as these institutions are converted to professional colleges under the NPPT. This desirable change in policy will help reduce recurrent costs, but the higher teacher salaries in the professional colleges and academic lycea add 50 percent to the salary bill by comparison to what teachers earn in general secondary schools. Higher recurrent costs also result from the smaller class sizes that academic lycea and professional colleges are intended to have (currently, the class sizes in the various programs have been disrupted due to the transition), and from the far more adequate provisioning o f these schools with educational materials and supplies than the old-format secondary schools. 3.16 The NPPT Program will have very high budget costs in thefuture. Because the unit costs o f the new professional colleges and academic lycea (Table 3.3) are so high, it will be very expensive to accommodate the expected increase in upper secondary enrollments in these schools unless ways are found to bring unit costs down. Under the 100 percent coverage and 90 percent vocational goals o f the NPPT, the recurrent budget costs o f secondary education (grades 10-12) of all types are projected conservatively to more than double in real terms (from 104 billion soums in 2002 to 234 billion soums in 2009 - Background Paper Annex I).The same demographic pressures that are leading to higher enrollments in upper secondary education will, however, lead to smaller enrollments in grades 1 through 9 during the coming decade. Enrollments in basic education are projected to decline from 5.6 million in 2002/3 to 4.3 million by the end o f the decade. At current unit costs, that decline implies a potential decline in total expenditures for basic education from 243 billion to 187 billion. Achieving those savings would require that the number o f teachers be reduced in direct proportion to the decline in enrollments, which would require far more discipline than has been evident in the past. And it may not be realistic to expect any significant savings because teacher salaries need to increase in order to motivate better teaching performance and attract new teachers. 3.17 It is questionablewhether the NPPT schools will meetfuture labor-market needs better than the old-format schools. The NPPT program's aggressive move to strengthen vocational secondary schools and to allocate a higher percentage o f students to these schools i s inconsistent with the global trend - especially in the OECD countries - away from secondary education systems which are segmented into separate academic and vocational streams.54Even in systems 54"Overall Trends in Secondary Curriculum Reforms in OECD and Balkan Countries.'' draft consultant report, the World Bank. May. 2004. 35 which have retained separate vocational and academic streams in secondary education, the proportion o f vocational enrollments typically ranges from 5 percent to 10 percent o f total enrollments. In Kyrgyzstan, the proportion is just 1 percent. Whether the NPPT program delivers on the very high expectations set for it depends upon whether the changes being introduced under the reform prove to be responsive future skill needs in the economy - in terms o f student demand, employment o f graduates, and needs for structural and content changes in education programs. The academic Zycea are too new to provide lessons on the labor market experience o f graduates. But there is limited information available from the Ministry o f Labor's quarterly labor-force survey on the employment experience o f recent graduates o f specialized secondary education. The extremes convey a clear message o f current job relevance: training in electronics repair, with an unemployment rate o f 2 percent, is job-relevant, while training o f cultural personnel, with an unemployment rate o f 51 percent, is not. For the intermediate cases, conclusions are not so obvious. The relatively low recorded unemployment rates for graduates o f mining and agriculture programs, and o f industrial programs in machine building, textile equipment, and high unemployment rates for graduates in clerical specializations (economics, legal, and computers) are the opposite o f the pattern observed in most o f the transition countries, where employment in personal and business services is tending to displace employment in manufacturing and primary production. Moreover, drawing longer-term inferences from current labor market experiences o f graduates i s risky. The fact that most recent graduates o f specialized programs in machine building are finding employment today i s no guarantee that they will find employment in the future, as market competition intensifies. The instability o f employment rates for graduates o f general secondary and specialized secondary education is illustrated by the experience o f Turkey (see Box 3.1). Box 3.1: The Experience o f Turkey with Vocational Education InTurkey, as the table below demonstrates, there was a dramatic shift in unemployment rates across different types of educational attainment between 1990 and 1994. As Turkey opened up and liberalized its economy, graduates with secondary general education achieved a reduction in unemployment: from 19.4 percent to 14.7 percent in four years, while graduates from vocational and technical high schools experienced a sharp increase in unemployment. This experience demonstrates that secondary general education tends to produce labor force more adapted to an open market economy, whereas graduates of vocational and technical schools may face difficulties in a liberalized labor market. The more aggressively Uzbekistan liberalizes its economy and enters into the mainstream of the global economy in the future, the more variable will be the demand for skills, and the greater will be the need for flexibility ineducationprograms. Reversal of UnemploymentRatesfor Graduatesof Secondary General and Secondary VocationalSchools, Turkey, 1990 and 1994 Level of education 1990 1994 d ? 8 0 x Illiterate 7.4 3.6 5.0 7.3 1.4 3.5 Literate without diploma 6.3 5.6 6.1 6.5 4.6 5.9 Primary school 8.3 8.0 8.2 8.7 5.3 7.8 Generaljunior high school 11.4 24.6 13.2 11.8 22.0 13.1 Voc.junior high school 11.0 16.4 12.2 21.1 7.5 18.7 General high school 12.6 35.8 19.4 11.7 24.1 14.7 Vocitech high school 6.7 19.3 9.6 12.6 24.0 15.1 Higher education 5.2 11.4 6.8 5.5 8.9 6.5 E. MANAGEMENTFINANCING EDUCATION AND OF 3.18 Education management is fragmented. Eighty percent o f all preschool, primary, and general secondary education institutions are managed by the Ministry o f Public Education (MPE). Higher Education is managed by the Ministry o f Higher Education (MHE). The old-format 36 specialized secondary vocational programs were managed either by other line ministries - especially, the Ministry o f Health and Ministry o f Commerce - or by the MHE's Center for Specialized Secondary Education. As the PTU's and technikums were phased out, management o f all the new specialized secondary schools was taken over by the Center for Specialized Secondary Education. This arrangement makes it difficult to assure coherence and efficiency o f management across the twelve grades o f the new compulsory education cycle. One particular area that needs attention is how to ensure cost-effective use o f the classroom capacity which i s liberated as grades 10 and 11 o f the former system are phased out. In many cases, it may make sense to use these facilities as academic lycea which are attached to grade 1-9 secondary schools. Higher education remains centrally financed and managed. The management o f most preschools, primary, secondary and specialized secondary schools is ostensibly decentralized to local governments (hokimiats). But there is a fundamental disconnect between local governments' responsibilities for managing education and their means for doing so. In order to keep schools functioning, the state budget finances whatever local governments - oblasts or rayons - are not able to finance through their own resources. It does so by varying the percentage o f the locally collected VAT and other central taxes. General secondary schools are financed through the MPE's budget; specialized secondary schools are financed through the budget o f MHE's Center for Specialized Secondary Education. 3.19 The existing education financing formula has deficiencies. This financing formula provides no room and no incentive for school principals or local government authorities to consider options for more efficient provision o f education. In principle, the state budget guarantees the financing o f core recurrent costs o f schools, consisting predominately o f teacher salaries and benefits. The number o f authorized teaching positions (and, in consequence, the level o f guaranteed state financing) in each locality i s driven by centrally established "norms" for maximum class size and teaching loads. Minimum teaching loads are very low by OECD standards. The minimumteaching load defines a teaching "norm", for which each teacher i s paid a base salary in accordance with the unified salary grid for budget organization^.^^ Additional teaching hours are paid at a pro-rated fraction o f the base salary, up to two full teaching norms. Most teachers supplement their income by teaching from 1.3 to 1.5 full norms. In addition, teachers who have taught at least twenty years and who reach the statutory retirement age (60 for men and 54 for women) can receive their full pensions and continue to teach. Central norms also dictate minimumclass sizes. But because o f the difficulty o f making alternative arrangements for small student numbers in rural areas, these standards are often not enforced. One consequence o f this process is inefficiency, which is implied by low studentheacher ratios. Another is the frustration of the intention that local government manage their own schools, because there is little for them to manage. F. RECOMMENDATIONS ANDOPTIONS FORREFININGEDUCATIONPOLICY F.l. Improvingthe Efficiencyand EquityofEducationExpenditures 3.20 The financing formula should be improved In order to provide the incentive for improved efficiency in education expenditures, Uzbekistan should consider moving to capitation- basedjnancingfor all levels of education, as it is piloting in Akkurghan rayon of Tashkentoblast under the USAID-jnanced PEAKS project. Per-student allocations should be differentiated to reflect intrinsic differences in the cost o f education delivery, such as the higher cost o f technical specializations, and greater population dispersion in rural areas (leading to small class sizes, and 55 In 2004 the govemment began to prepare for the introduction of a special salary grid to be applied to the education sector only. 37 higher transport, heating and utility costs) (see Box 3.2). The formula could also build in incentives to motivate other desired behavior, such as educational innovation, or providing education for children with special learning needs. A still more advanced approach to formula financing o f education is to finance educational results rather than enrollments. Some o f the charter school contracts in the United States, for example, condition the payment to private education providers on the achievement o f agreed educational targets in terms o f learning achievement. The Czech model for subsidizing private education embodies the same approach: it finances a higher proportion o f recurrent costs for schools which meet higher quality standards. This approach is likely to grow in use as the capacity for assessing school performance - for example, through externally developed examinations -- improves. Box 3.2: A Composite Formula for EducationFinance Component Dimensions Indicators Basic Per-StudentAllocation total enrollment, Full-time equivalent (FTE) enrollments by grade differentiated by grade and type of program and program School Site Needs school size Primary < 200 FTE Secondary < 600 FTE school remoteness Kilometers to town of 50,000+ persons operations and Interior area of school in square meters maintenancecosts Student SupplementaryEducational socio-economic hardship percent of students from households receiving Needs social assistance low educational number of students below 20thpercentile achievement assessment results non-fluency in national percent of students below cut-off score in language national language test disabilities and special number of students formally assessed with special learningneeds learningneeds Educational Quality Improvement specialized curriculum FTE enrolled in specialized program specialized school Total FTE (ifspecial curriculum school) Adapted from "Principles for DesigningNeeds-Based School FundingFormulae", RosalindLevatid, and Kenneth Ross. in Needs-BasedResourceAllocation in Education via Formula Funding ojSchools, edited by KennethRoss and Rosalind LevaEiC, InternationalInstitutefor Education Planning, UNESCO, Paris. 1999. 3.21 Further measures are needed to address equity concerns. The proposed capitation formula described above would bring about improved efficiency, but would not address the equity issue that results from differences in informal contributions to school by households and communities, and place-specific differences in unit costs. Beyond the effects o f household poverty, the most systematic differences in education quality are those between urban and rural schools, reflecting the poorer resource endowment o f rural schools, and also the generally lower qualifications and experience o f teachers and parents in rural areas. Cost differences are exacerbated by resource differences between urban and rural areas. Higher unit costs o f education are most prevalent in areas with the smallest revenue base, so they tend to reinforce the inequality in revenue capacity among localities. Further specific measures to address educational inequities are recommended, such as raising the ceiling for budget support for textbooks and other educational requirements for needy students, and provision o f school meals in low-income areas with problems o f incomplete school attendance. 3.22 Education norms should be revised to encourage better efficiency. Capitation financing can provide the opportunity and incentive for efficiency gains only if the existing constraints on class size are relaxed or removed and minimum teaching loads significantly increased. As it is, most teachers teach well above the minimum teaching-hour requirement. It would send a much more positive signal to teachers if the minimum teaching load were significantly increased and 38 the base teaching salary were increased by the same amount. If minimum teaching loads were doubled, it would bring them into the range o f the United States, although they would not have to increase by this much to achieve the same purpose. This measure would be almost c o ~ t l e s syet , ~ ~ it would help to underline the Government's intention to make a significant improvement in education quality. Teaching loads are being increased as part o f the recently enacted salary increases for teachers, and further increases are contemplated. Class size restrictions should also be relaxed to give more discretion to local governments in reconfiguring schools to achieve better efficiency and better educational results. 3-23 More effective instruments of quality assurance should be developed. In Uzbekistan, as inother transition countries, class-size ceilings and teaching-hour ceilings are intended to prevent an erosion o f education quality that could result from overzealous cost cutting. But the experience o f all the transition countries over the past decade has shown that these input controls are not effective instruments for quality assurance. Quality differences among schools have grown as a result o f diversified financing o f education and differences in the capacities o f communities and households. Quality assurance should be carried out not through the blunt instrument o f input controls, but through instruments more closely related to schools' intended outputs -- through assessment o f teaching practices and classroom results. The preferred approach for doing this i s through value-added measures o f student learning achievement as established through high-quality external assessment. This is a very desirable activity for Uzbekistan to undertake, and many other transition countries are doing it -- often, with the assistance o f external partners. But it requires a serious, long-term commitment to develop the test items for this form o f assessment and the capacity to implement it successfully. In the meantime, Uzbekistan could develop less demanding instruments, such as school report cards, to monitor schools' performance through simple, readily accessible indicators such as student retention, attendance, transition to higher levels o f education, and parental satisfaction with schools. 3.24 Reform actions should be sequenced. Moving to capitation financing requires careful preparation that would take at least two years (including preparatory work o f data gathering, and preparing, piloting, and evaluating a capitation formula as well as study visits and training for the people involved in implementation). In addition to carrying out these preparatory actions, what could be done in the meantime to move towards better efficiency and equity o f education financing? Increasing the ceiling on social benefits to students fiom poor households i s one desirable action that could be implemented immediately, and would bring important equity benefits. Prior to introducing a new capitation scheme for school financing, it would be desirable to increase minimum teaching loads and teacher salaries very signlficantly (and by at least the same amount). F.2. Refiningthe NPPT Strategy 3.25 Action can and should be taken now. This report recommends considering a fundamentally different approach, in which secondary education would provide a general education and the basis for subsequent occupation-specific andjob-specific training which would be provided through life-long learning financed either by individuals or by employers (or both). Even if the Government fully implements the original NPPT, the program may tend to evolve in this direction over time as the economy develops (and, with it, enterprises' capacity to provide specific training to meet their own needs), and as the country can defer job-specific training to the 56 It would not be fully budget-neutral because some teachers would need to be paid at the new, higher salary if, through no fault of their own, it was not possible for themto teachthe minimum number of hours. 39 post-secondary level. However, short o f this major reorientation o f the NPPT, there are a number o f ways in which the concerns about cost-effectiveness, labor-market responsiveness, and equity o f the program could be addressed. 3.26 Existing general secondary schools can be used more cost-effectively. The plan to build an entirely new network o f academic lycea and professional colleges for grades 10 through 12 will add to the redundant capacity in existing general secondary schools which will arise in the coming years due to the shrinkage o f the 5-14 year cohort. Rather than continuing to build new schools, it would therefore be more cost-effective in many cases to carry out a major upgrade o f existing general secondary schools, together with modernization o f teaching methods and materials, and to provide grades 10-12 o f upgraded general education inthose schools rather than in new academic lycea. One option that the Government may wish to consider is to improve general education within the framework o f the NPPT by upgrading some of the existing general secondary schools and extending their duration through grade 12, rather than doing this exclusively through newly constructed academic lycea. These grades within general secondary schools could be designated as academic lycea (as in Hungary, where vocational secondary schools are often combined with grammar schools). It would be easier to manage this option if the Ministry o f Public Education and Ministry o f Higher Education were merged. Merging the two ministries would make it easier in many respects to develop a coherent strategy and consistent standards for primary and secondary education (not to mention higher education), but would not be essential for implementingthis option. 3.27 Professional college curricula can be consolidated in order to improve job flexibility for graduates. In order to increase the flexibility o f skill training, it would be desirable to strengthen the academic content - particularly in information and communication technologies (ICT) and foreign languages - and reduce the vocational content in the curricula o f the professional colleges. It would also promote flexibility to consolidate the existing specializations o f the professional colleges to a small number of broad occupational clusters with kindred skill requirements. Hungary has carried out such a consolidation, reducing the number o f specializations in its secondary vocational schools from well over a hundredto fewer than twenty. Many other countries - both transition and non-transition - are in the process o f doing the same. Although it would take time to develop the new curricula, training materials, and teacher training to fully implement this option, it could be done within the framework o f the NPPT program. Preparatory work could start immediately with very modest budget support. This option could also involve reducing or making optional the in-enterprise portion o f the training inprofessional colleges, which will otherwise constrain full implementation o fthe NPPT. 3.28 Modernizing teaching and learning methods would improve labor-market relevance and encourage innovation. Making teaching and learning methods more student-centered and inquiry-based could make a major contribution to labor-market responsiveness o f education and the capacity o f graduates to be innovative and flexible throughout their working lives. Because this option involves education methodology rather than education structure, it would not require a change in NPPT. Modernizing teaching and learning methods i s a long-term effort that could start now, within the resources (including the donor resources) already available. Successful implementation would depend crucially on changing classroom teaching practices. This would require a large-scale effort to embed the desired teaching practices in pre-service and in-service training o f teachers. It would also require the development, over time, of new textbooks, teachers' manuals, and other pedagogical support for the new teaching and learning methods. Finally, it would require that the new teaching practices be embedded in the evaluation o f schools and teachers, and linked to the compensation o f teachers. The OECD has developed a new instrument for student assessment that focuses specifically on the skills needed to compete 40 successfully in the rapidly changing world o f the global economy. This Programme for International Student Assessment (PISA) assessment provides a basis for international comparison o f education systems' performance along new dimensions, and has become a powerful instrument for reform o f teaching and learning practices. All o f the OECD countries and several o f the more progressive transition countries are participating. If Uzbekistan is interested in strengthening these aspects o f teaching and learning practice in its education system, it would be very helpful for itto participate inthe PISA assessment. 3.29 Education and training should continue beyond formal schooling. In a liberal economy, firm-specific productivity gains should motivate employers to finance training; more broadly applicable earnings gains should motivate individuals to acquire and finance training. An approach that is well established in some EU member states is central government incentives for employers to provide training for their employees - for example, in the form o f vocational training levies. Vocational training levies are equivalent to a payroll tax combined with a tax credit for enterprise-provided training. This is a very costly instrument for promoting training. Such initiatives to protect the rights o f workers add significantly to the cost o f employment, and thereby discourage job creation and worker mobility. Training credits are also a very blunt instrument for motivating employers to provide training which i s relevant to their employees' long-term training needs. Instead, they provide an incentive for employers to provide job-specific training which reduces rather than enhances their workers' mobility. And it i s questionable whether they lead to workers receiving more training. In the presence o f minimal public incentives for training,57 employers in the United States provide far more training to their employees than employers in countries with vocational training levies. The crucial requirement i s to establish the legal and fiscal enabling environment to allow and encourage enterprises to provide training for their own employees, and for private firms or NGOs to develop training capacity and provide training to individuals and employees o f firms. F.3 Addressingthe NeedsofBasic Education 3.30 In order to obtain the full benefit of the Government's new investment program in Basic Education, particular attention should be given to ensuring the necessary recurrent budget inputs and to monitoring and evaluating the educational outcomes of the program. Inclusion o f performance incentives as part o f the recent increase in teacher salaries i s a very positive action to motivate teachers to focus on improved educational outcomes. Attention should also be given to eliminating the teacher salary discrepancy between lower and upper secondary education. The better salaries offered to teachers in the new upper secondary schools has drawn away many o f the most qualified teachers in primary and lower secondary education. Basic education needs more adequate budgets for non-salary recurrent inputs to quality education, including up-to-date teaching and learning materials. Pedagogy needs to be modernized as described above. A cost assessment, such as the one recommended as part of the process of developing a new financing formula, could help to define the needs for basic education o f minimally acceptable quality. But funding basic education more adequately need not and should not wait untilthis cost assessment i s done or until a new financing formula i s in place. It could be done under the existing financing process and formula. 57 Employers in the US can deduct training costs as a business cost - a far weaker incentive than a tax credit for training. 41 F.4. DevelopingHigher Education 3.3 1 Imaginative policy solutions are needed to equip higher educationto meet the needsfor investment-driven and innovation-drivengrowth. In order to perform this role, higher education programs need serious investments to improve quality, such as improved laboratories and university library facilities. In the situation o f constrained budgets, how can Uzbekistan afford to make these improvements while enrollments continue to expand? 3.32 The introduction of contractplaces in higher education addressed the need to mobilize additional resources, but in the process has brought about an undesirable segmentation of education within universities. It has also exacerbated educational inequities, since poorer students are less likely to win budget-financed places because their primary and secondary schools are more likely to be o f inferior quality, and because they have less access to paid tutorial instruction to prepare them for the university entrance exam. They are thus more likely to have to pay for their higher education than are more affluent students. 3.33 Private higher education should be encouraged. The simplest measure for expanding higher education without committing additional budget resources i s to encourage the development o f private universities. Private universities not only provide an alternative to budget-financed higher education; they also provide alternative models for delivery and quality o f higher education. In countries with diversified systems o f higher education, private universities typically provide both the highest and the lowest quality options for higher education. The best o f these can provide valuable models for other universities - including public universities-- to emulate. This element o f competition is an important benefit o f developing a healthy private education sector. Private universities have developed rapidly in most o f the accession countries during the transition, but less so in the FSU countries. Uzbekistan has no private universities. Where private universities have developed, mechanisms to ensure that private higher education is o f acceptable quality have been slower to develop, leading to serious concerns in some o f the accession countries about quality standards. Inthe short term, the most practical means o f quality assurance i s through the criteria for certifying and recertifying educational institutions, based on indicators such as the number o f full-time faculty with postgraduate degrees, and the course requirements for graduation. Over time, such criteria may prove unnecessarily restrictive. In the medium term, it would be preferable to move to a looser, voluntary system o f accreditation in which private universities would set their own quality standards and enforce those standards through self-regulated, voluntary accreditation associations. This approach is also most consistent with the market model, in which education is free to respond to demands and the capacities o f diverse clients. 3.34 Budget financing of higher education should be used more selectively. The current system o f higher education finance tries to finance all university education through the state budget, and allows cost recovery through student fees only as an expedient response to budget shortages. It would be preferable to use public financing o f higher education more selectively to achieve specific objectives. There are various approaches to financing the development o f higher education (see Box 3.3). The ideal solution would consist o f a combination o f these measures, including allocation of public funds on a per-student basis, subject to meeting explicit performance standards. F.5.ImprovingEconomic Outcomes 3.35 The Government and the country have made major sacrifices to invest heavily in education during the past eight years - first in the form o f the NPPT, and now in basic education. 42 Box 3.3: Approaches to Financing Higher Education Allow higher education institutions to generate and retain income throughprovision ofprofessional services. This simple measure: which has been adopted by most of the transition countries; can help develop links between academe and the economy, but it needs to be implementedjudiciously in each institution in order to prevent the income-earningrole from displacing the roles of education and research. Cost recovery through student fees. Student fees are necessary in most education systems to limit what would otherwise be excessive demand for education (just as hospital and pharmacy co-payments for insured health services are necessary to prevent excessive hospital use and drug use). There are widely varying approaches to collection of student fees in higher education. The Czech Republic has resisted imposing student fees in higher education; Slovakia allows student fees only for part-time courses (which, however, are very popular in highly demanded new areas such as IT). The problemthat fees tend to discourage attendance by capable students from poor households can be mitigated, but not eliminated: by combining student fees with a means-testedscholarship scheme or a student loan scheme. But in order to performthis role effectively, student loan schemes must receive budget-financed interest subsidies. Neither of these approaches addresses the bias which results from the fact that students from higher-incomefamilies are more able to afford privatetutoring and the informal fees to attend better schools, and thus to obtain higher scores on their university entrance examinations and free admission to the higher educationprograms oftheir choice. Restrict state budget financing to either the most capable students or the highest performing institutions. The system of fee-based contract education in Uzbekistan (and most of the other transition countries) is an example o f the former. An alternative is restricting budget financing to centers of excellence to serve as a model for other institutions to follow. This amounts to budget triage: public budget financing is restricted to the leading universitieswhich are financed amply as centers of excellence, with other institutionsof higher education finding their own financing and establishingtheir own standards of quality. This can be an effective approach, as the US model of parallel public and private higher education institutions demonstrates, but an effective accreditation system is necessary in order for this model to functionwithout creatingfalse expectations on the part ofthe public. It also entails equityproblems, since it provides no support for capable students from poor households. A model that is in many ways preferable is the mixedfinancingformula - for example, the UK model- in which all universities can receive public financing on a per-student basis; subject to meeting explicit performance standards. This model has importantadvantagesof flexibility (combiningcost recovery with public subsidization) and focusing on educational outcomes (in terms o f students, graduates, and academic achievement). It can also easily accommodate other goals such as inclusiveness by including affirmative action indicators among the eligibility or performancecriteriafor financing. Equity concerns can be addressedwith student loanschemes. A major motivation for these human capital investments is to improve employment prospects, productivity, and earnings for the graduatesof these programs as they enter the labor market. But these benefits will not materialize if the conditions in the economy are not conducive to job creation(including self-employment and new enterprise start-ups), foreign direct investment, and adoption of new, more productive technologies. Capturing the full benefits of the country's major investments in education will require more aggressive progress on economic reforms to liberalize the economy, reduce state interventions and administrative controls, stimulate privatization, competitiveness, job creation and foreign direct investment - including increasing transparency and implementing policies to control rent-seekingbehavior by regulatory officials and state capture by public organizations. 43 CHAPTER4. PUBLICEXPENDITUREMANAGEMENT A. INTRODUCTION 4.1 Uzbekistan has been undergoing major reforms inthe field o f health and education, as the previous chapters show. These reforms will be difficult to fully implement without major changes to the budget process, including significant changes to the role o f government institutions. This chapter will consider the nature o f these changes. It will discuss the necessary reforms to the budget preparation and execution, some o f which have already been initiated. It will not cover closely related reforms to mechanisms o f evaluation and accountability (particularly in internal and external audit) which are the subject o f the Country Financial Accountability Assessment (CFAA) whose recommendations are an essential complement to the ones discussed here. 4.2 Budget process reform requires a fundamental change in institutions. Under central planning, budgeting was an accounting exercise separated from policy making. No institutions were required to make the necessary policy choices on what activities could be financed. The greatest challenge in reforming the public finances i s to make the transition from the institutions inherited from the centrally planned economy - which are currently prevalent in Uzbekistan - to ones in which policy making i s linked to budgeting. Only then can the principles o f modern budgeting (including comprehensiveness, accountability, transparency and a medium term outlook; see Box 4.1) be made effective. To apply these principles, in many countries there has been a strong convergence towards large streamlined ministries with broad sectoral responsibilities. The ministries play a prominent role in prioritizing and allocating resources during budget preparation and there is a clear delineation o f roles and responsibilities between different levels o f government. Box 4.1: Principles of Modern Budgeting The budget is comprehensive and allocates fl the financial resources available to the state to public institutions in order to achieve specific feasible objectives. Institutions and individual managers (particularly ministries and ministers) are held publicly accountable for the use of the resources allocated to them to achieve objectives. Effective accountability requires allocations to institutionsand programs to be known publicly and subject to review or audit. Ministriesplay a key role in policy formulation and in developing priorities and alternatives for the use ofpublic resources, within explicit ceilings of available resources. Annual budget processes are based upon a medium term perspective, in which the future implications of current decisions are taken into account. B. INSTITUTIONALARRANGEMENTSFORBUDGET FORMULATION B.l. InstitutionalArrangements 4.3 I n practice there are no separate Republican and Local Budgets, reflecting national and localpriorities. The State Budget is the sum o f the Republican (central government) budget and Oblast budgets (including their subordinated Rayons). While there is a formal separation between the central and local levels o f government, in practice the system is one o f deconcentrated government, with the 14 oblasts5* and the 210 rayons treated as if they were central government units. Annual budget negotiations between the MOF and oblasts result in 58The 12 regions ofUzbekistan plus the city of Tashkent and the autonomousRepublic of Karakalpakstan. 44 decisions about adjustment o f revenue shares to fill the gaps between the revenues and expenditures. Separate revenue shares are established for each oblast and rayon and each tax type every year making the process unpredictable and n~n-transparent.~~Central decisions (for example to build a new hospital or expand vocational education) are simply included in local budgets. 4.4 Dual subordination makes accountability difficult. Within each oblast and rayon there are sectoral departments o f the central ministries. The Financial Departments (deconcentrated units o f the MOF) are formally part o f oblast and rayon administrations and are responsible for budget preparation and execution at the local level. Despite their formal status as part o f local government, sector departments maintain a relationship o f "dual subordination" to the local government and the central ministry. The result i s that there are no clear lines o f accountability for either policy or the use of resources. 4.5 Policy making functions of Ministries need to be developed. In Uzbekistan, policy development takes place centrally in the apparatus o f the C O M and the Presidential Administration. However sectoral units at the center are too small to carry out effective detailed policy development, while the capacity and authority o f line ministries to develop policy is extremely limited. Policy development at the center takes place outside o f the budgeting process, which implies that funding for new initiatives will either be lacking or will be allocated in an ad hoc manner by the MOF. Along with other ministries, the MOF maintains an outdated structure. In particular the budgetary functions of the Ministry are distributedacross a number o f sectoral departments, each reporting to a different Deputy Minister, who will also be responsible for other unrelated functions6'. The MOF does not have a department for macro-economic analysis and forecasting. Such a department i s necessary both for the MOF to be able to give informed policy advice on economic policy and to form a basis for the development o f the resource envelope for the budget. B.2. LegalFramework 4.6 The legal framework for the budget process requires strengthening. Under the Constitution the Oliy Majlis approves the State Budget, but crucially does not enact6' it. The 2000 Budget System Law (BSL) provides the framework for budgeting in Uzbekistan. It specifies broad responsibilities o f all parties and the processes to be followed in budget preparation, approval, budget execution, reporting and control. However the BSL requires some amendments to make it consistent with international best practice (see Box 4.2). 59In the 2004 budget, 21 percent of spending from local budgets was financed by truly local taxes (mainly property taxes), but the proportion varies widely across regions from close to 50 percent in Tashkent to less than 10 percent in less developedregions. 6oFor example, the Department for Financing Defense and Law enforcement is under the Deputy Minister responsible for external debt and investment. while the department for Financing the Ago-Industrial Complex i s under the Deputy Minister responsiblefor Accounting Methodology and Tax Policy. 6'Enactment implies that the legislature provides legal authorization for appropriating funds from the public account, and is able to hold institutionsto account for such spending. 45 Box 4.2: Key Areas for Improvement of the Budget System Law The BSL does not include provisions allowing for the enactment of the Budget or to ensure that legislative actions to increase expenditures can only go into effect if authorized inthe Budget. Appropriations are not clearly defined as an authority to spend separate from actual cash resources. The BSL stipulatesthat the budgets of Extrabudgetary Funds should be consolidatedinto the State Budget (Article 9):but does not require the same processes of preparation, execution, reporting and audit as for the rest of the budget. Expendituresfinanced from foreign sources are not clearly subject to the BSL. The BSL gives deadlines for budget preparation and empowers the MOF to supervise the budget preparation activities, but does not assign clear responsibilities for these. For example, no responsibility is assigned for the preparation ofthe macroeconomicframework. Definitions of revenues and expenditures include contracting and repaying debt and are not consistent with international standards. The BSL provides for a system of inter-budgetary transfers betweenthe Republican Budget, oblastsand rayons, but does not specify the principles of operation of such a system. The BSLstipulatesthat the Oliy Majlis must approve annual debt limits, but does not stipulate that guarantees should be submittedto the Oliy Majlis for approval. The BSL does not give full authority to the MOF to manage debt and financial assets. C. THEBUDGETPROCESS C.l. Current Budget 4.7 The MOF deals with a large number of budget holders. There are in effect two budget processes. The first broadly covers current expenditure, and the second covers investment expenditure under the Public Investment Program (PIP). The current budget process begins when the MOF issues its budget circular in May or June, for the recurrent republican and oblast budgets. The MOF receives budget requests from over 100 primary budget holders62and 14 oblasts (consolidated with the budget request o f their subordinate rayons). The C O M indicates areas o f particular priority, such as education, at the beginningo f the budget preparationprocess. 4.8 Until recently there was no initial resource envelope based on a macroeconomic framework nor were expenditure ceilings specified to line ministries when calling for their budget requests. The MOF uses some macroeconomic indicators - prepared by the Ministry o f Economy (MOE) - to determine an ex-ante expenditure ceiling so that a certain ratio o f government expenditure to GDP is not exceeded. However, these parameters are not part o f a coherent macroeconomic framework within a formal macroeconomic model. For the first time in the 2005 budget process expenditure ceilings were set for sectors. This is an important step forward in the budget process. However the process o f setting ceilings will require further development and formalization. In particular, it is important that the C O M approve ceilings for institutions and notjust functions, and that the process o f setting ceilings should be codified in the BSL or in regulations issued by the MOF based on the BSL. The budget preparationprocess still consists o f a bottom-up approach involving line ministries simply aggregating individual budget requests by budget institutions (BIs). Unrealistic demands for budget resources have to be scaled back by the MOF without it having sufficient data at its disposal to make coherent decisions. Moreover the analysis o f the budget requests takes place by the corresponding sector departments o f the MOF and there is no overall view o f the budgetpriorities. 62These include ministries, committees, enterprises and other types of organizations. Incountries with reformed budget processes: the MOF will deal directly with about 20 or 30 ministries, which are responsible for the budgets of all agencies within their sectors. 46 4.9 Budget requests are based upon standard cost norms and historic allocations. The budget proposals submitted by BIs contain requests on the basis o f four major economic categories: wages; taxes and social security contributions; capital expenditure; and other current e~penditure~~. BIs prepare their requests mostly with reference to nationwide applicable pre-determined cost norms and standards. In some cases the norms are still based upon legislation dating back to before 1991. In the case o f local budget institutions, requests are reviewed at oblast level and the proposals, including the financing gaps to be filled, are forwarded to the MOF. The MOF reviews the proposals in terms o f their consistency with current regulations, and applies cuts mainly to the category of other expenditure, which ofen leads to a lack of maintenance and supplies. 4.10 A draft budget on broad functional Table 4.1: State Budget Expenditure, 2004 classificationsis approvedby the COMand Oliy ~~ Majlis. After reconciling the revenues and Total expenditure 3,679.616 expenditures with a deficit target, the draft Social Sphere 1.305.416 budget is presented on a very aggregate ofwhich: functional basis successively to an Education 753,361 interministerial committee, the C O M and finally Healthcareand Sport 282.213 the Oliy Majlis for approval (usually by Science, Culture, Mass-media 51.291 December). The State Budget approved by the Social security 10.791 Oliy Majlis and the C O M consists o f only ten expenditure items (by broad functional Subsidies 21,740 categories - see example o f 2004 budget) and Family benefits 167,136 thirteen revenue items by main revenue sources Expenditures on Economy' 667,022 together with total revenues (including State Power and Administration 69,933 subventions) and expenditures o f each oblast. Other Expenditures 700.857 4.1 1 Evaluation and accountability require a ' Includesthe Extrabudgetary funds' 936,386 domestic financing of Public different classificationand greater detail. While Program. substantial additional documentation on the *ExpenditurePension Includes Fund. performance o f the economy i s presented to the Oliy Majlis, the presentation o f the budget does not allow the Oliy Majlis (or the COM) to make an assessment o f the effectiveness of the allocation o f resources (or provide strategic guidance on resource allocation, given that approval is granted at the end o f the budget process), and even less to require accountability for their use. The Budget does not show either the sectoral breakdown o f the investment nor the expected volumes o f expenditure to be financed by external borrowing or grants. 4.12 The detailed budget isprepared after approval by the Oliy Majlis. Once this process has been completed a second (arguably the real) budget process begins. Since the budget approved by the legislature does not assign resources to institutions and economic categories, it is only following the approval of the budgets that the negotiations and allocation o f budgets o f institutions at the central level takes place by the MOF, often during the first weeks o f the year for which the budget has been approved. 63 This includes the purchase of goods and services (e.g., food, medicine, administrative costs, utilities and maintenance). 47 C.2. InvestmentBudget 4.13 There is no integrated evaluation of investment and current spending in each sector. The lead agency for the investment budget is not the MOF but the MOE, which is responsible for the PIP.64AlthoughMOF officials are involved in this process and all projects are formally subject to a process of appraisal, they are not evaluatedtogether with other public resourcesbeing assigned to a particular sector, within a budgetary envelope for the sector. In addition, a number of basic decisions in the PIP are taken outside the formal budget process (for example, a priori decisions on the number of schools and hospitals to be constructed). There i s also no mechanism for the consideration of the impact of future recurrent cost implications (beyond the next budget year) of new investments. Box 4.3: Investment in the Education Sector: Separation of the Investment and Current Budget The secondaryeducation sector Uzbekistanis spendingover six times the OECD average on each student in the new style secondary schools: as a result of heavy investment in the specializedsecondary schools. By 2003 investmentin these schools amounted to 53 percent o ftotal public investment in the Budget. This investment is also raisingcurrent costs per pupil (50 percenthigher than in standard schools). It is questionable whether such expenditures are optimal and would bejustified under a comprehensive budget process in which the potential retums and future implications of these expenditures were measuredagainst alternative uses of resources either within the education sector or to other sectors. 4.14 The PIP has a short term perspective. Two three year PIPSwere prepared for 1999- 2001 and 2000-2002, but for 2003 and 2004 have been prepared only on an annual basis, and are not based upon explicit medium term priorities or linked to broader national or sectoral programs. The investments included are thus most likely to be ad hoc choices by the agencies involved in project selection. 4.15 Separation of PIP and external financing promotes the view that such resources are additional or free. A significant proportion of the PIP i s financed from external borrowing, the existence of the PIP in its present form promotes the view that foreign financing i s "free" money apart from the budget. Although the appraisal of PIP projects does include an assessment of the ability to repay the loans, these are not taken into account as part of the budgetary envelope available for spending by institutions. C.3. Budget Classification 4.16 The budget classi@?cation used does notfollow international standards. The functional classification is a mix of functional elements and economic categories, and the economic classification is limited to four categories, as noted above. Currently, a new budget classification consistent with GFS 2001 has been developed with the assistance of the IMF and U S Treasury. It is expected that this will be implemented for the 2006 budget and that, in addition, a programmatic budget classification will be implemented from 2007. 64The PIP covers both General Govemment investment (centralizedinvestments) as well as that carried out by public enterprisesfinanced from their own resources and direct foreign investment (decentralizedinvestments). 48 C.4. Transparencyand budget presentation 4.17 Transparency in the budget process needs to be improved. The current budget preparation process is not tran~parent~~and suffers from the fragmentation o f the budget. Greater transparency can be achieved through the presentation o f the budget by organizational and economic classification, together with comparative data for the previous year and forecasts for the succeeding two years. A typical set o f budget documentation i s described in B o x 4.4. This documentation would enable policy makers, the Oliy Majlis and the wider public to understand and question the fundamental decisions in the budget and to hold the government accountable for budgetary decisions. While the development o f high quality documentation may take place over a number o f budget cycles, it i s important in principle that the assumptions and main policy lines underlying budget choices are clearly presentedto the Government, Parliament and the public. Box 4.4: Typical Documentation for Submission to Cabinet and Parliament 1. Overview of budget which will set out the major directionsof fiscal policy and major budget initiatives. 2. Draft annual budget law setting out proposed budget appropriations and revenue estimates of the budget year, estimates o f expenditure, and forecast revenue for the two forward years based on budget policy settings, plus one year inthe pastby functional, administrative,economic and programclassification. Fiscal Strategy and EconomicOutlook including updated forecasts of macroeconomic indicatorsand assumptions and Govemment'smediumterm fiscal objectives and budgetpriorities. Statement of Budget Measures identifying specific measures of expenditure (including public investment), revenue and financingtransactions(such as sales of assets) proposedby the Govemment. Resourcingof Ministries and Agencies providing details of individual programs by agency, providing details of program objectives, expected outcomes, resource allocation by program, function, economic and administrative classification. 6. Overview of intergovemmental fiscal relations: current expenditure and revenue assignments, subventions (amounts and basis of calculation), specific purpose paymentsto sub-nationalgovernment. major capital projects at sub-nationallevel, outlook (andfuture reforms)o f intergovemmentalfiscal relations. 7. A statement on the financing of the deficit and guarantees and other contingent liabilities including main sources -o f intemal and extemal financing and all guarantees issuedand likely to be called. 4.18 Transparency and accountability would be enhanced by the publication of Budget documentation. Publication is standard international practice in virtually all countries in the world, and is also consistent with the recommendations o f the Country Economic Memorandum and the CFAA. The decision o f the Government to begin publishing the details o f budget execution for 2003 i s very welcome and institutionalization o f this practice would be an important step forward intransparency. C.5. Budget ExecutionArrangements 4.19 Fragmented organizational arrangements for the budget make implementation disficultto monitor. Budget execution takes place through the Central Bank o f Uzbekistan (CBU) and the banking system, using authorities issued by the MOF and the Oblast Finance Departments. The C B U estimates that there are 120,000 Government bank accounts. There is a lack o f separation between the release o f the authority to spend and the release o f cash to spending units. Budget appropriations are released through transfers from higher to lower level bank accounts. These procedures allow spending agencies and intermediate government institutions to build up idle cash balances, thus increasing the MOF's gross borrowing requirement. 65 Prior to 2004, even the few aggregate items o f the budget were not widely publicly disseminated, although for the first time in 2004 these were published on the internet and the Govemmenthas committed itself to publishing a more detailedsummary of the execution ofthe 2003 budget. 49 4.20 There is uncertainty in the availability and timing of funds. In principle, budget funds are released to spending agencies on the basis o f monthly expenditure plans. Although funds are released over the whole year in accordance with the approved budget, to keep cash under control, these releases are not automatic and are prioritized by the MOF or the Oblast Finance Department. The timing o f availability o f funds is determined in part by the availability o f revenue (dependent on seasonal or local fluctuations) at the relevant level o f decision-making (MOF, oblast or rayon). The need for prioritization@ in release o f cash makes control o f execution a source o f political and economic power, and subject to lobbying and rent-seeking6'. The resulting uncertainty as to the timing o f the release o f funds generates incentives to cash hoarding and the accumulation o f idle balances by budget organizations. Cash management is further complicated by the rationingo f cash (MO)by the CBU to the banking system. Evenwhen funds are made available through the banking system to the bank accounts o f BIs, these are unable to make payments in cash to final recipients. As a result, arrears o f several months have occurred in wage and pension payments in some areas. C.6. BudgetFragmentation 4.21 Uncertainty and lack of funds leads to afragmentation of the budget. The uncertainty on the availability o f financing, both at the stage o f approving the budget and also duringbudget execution, has led to a number o f strategies by institutions to protect the resources allocated to them through the fragmentation o f the budget. This fragmentation is manifested in a number o f ways. 4.22 Creation of Extrabudgetary Funds. The first is the creation o f extrabudgetary funds6'. These funds have been created with their own sources o f income, and most o f the smaller ones cover current expenditures such as maintenance, repairs or subsidies in different sectors, which are precisely the items being squeezed under the current budgeting process. The creation o f extrabudgetary funds for these purposes is a substitute for an effective budget process and reflects an inability to prioritize. If an overriding need for maintenance, staff incentives or any other expenditure is recognized, this should be provided for through the normal budget process. There are arguments for maintaining the larger funds, but only if these are subject to standard budget preparation and review and audit processes as recommended by the CFAA. It is recognized that the Government is making efforts to reduce the number o f extrabudgetary funds, but in this context the creation o f a new fund for basic education i s a cause for concern, because o f the way inwhich this substitutes for the normal budget process. 4.23 Extra-budgetary accounts in the banking system weaken fiscal control. Spending agencies use extra-budgetary accounts69 (established under decree 414) to manage their own resources. While such arrangements facilitate cost recovery, the high number o f extra-budgetary bank accounts maintained by BIs create loopholes in fiscal control. 4.24 The Budget isfurther fragmented by the distribution of function responsibilitiesacross a large number of primary budget holders7' and the separation of the current and investment 66Priority is given to wages, pensions and utility payments. 67The problem is exacerbated by unclear lines of accountability of the local finance departments which report to both the MOF and the Oblast authorities. 68Currently there are over 20 (see the CFAA for more details) including the Pension Fund, Employment Fund, State Asset Fund and Road Fund. In the 2003 budget, all the extrabudgetary funds accounted for 26 percent of total expenditure (the Pension fund alone accounted for 18 percent of total expenditure). The remaining smaller funds accounted for about 2 percent of total expenditure. 69See the CFAA for a detailed explanation ofthese accounts. 70For example, educationis split across 27 budget holders (including two ministries o f education). 50 budgets. This makes it very difficult to develop clear sectoral policies or a rational allocation o f resources to fund policies within a sector. D. IMPACTAND EXAMPLES SYSTEMDYSFUNCTIONS OF 4.25 Policy reform is made difficult by the current budget system. In both the health and education sectors, major policy reforms have taken place in recent years. However, many o f the problems and difficulties with the reform process in both these sectors are closely linked to dysfunctions in the budget preparation and execution process. For example, the reforms in the health sector emphasize a move towards primary health care and away from hospital care. Although some reductions have been made in hospital facilities and use o f hospitals (by between 13 and 14 percent in the country as a whole between 1997 and 2001), the number o f medical personnel declined by far less (2.8 percent for mid level personnel and 5.5 percent for physicians). In education, very little school consolidation has taken place at all as the system provides no incentives for the reallocation o f resources or the closure or consolidation o f institutions, since the level'l at which `such decisions can be made will generally lead to a reduction in future budgetary allocations, due to the prevalence o f standard norms for determining budget allocations. 4.26 The bias against maintenance and running costs is unsustainable. Since maintenance and supplies are effectively determined as residual during both budget preparation and execution (due to the prioritization o f payments to protected items), these reductions are locked in for the future, since budget allocations reflect both the input norms and past spending. The effect i s that in the education sector spending on teaching and learning materials and school infrastructure has deteriorated to the extent that only 2 percent o f the budget in general education i s spent on equipment and supplies, less than 3 percent on major renovations and only 0.4 percent on preventative maintenance. Programs cannot be sustained indefinitely with such low levels o f spendingon these items. 4.21 Theproblem is in the budgetprocess -not simply a lack of resources. There has been a considerable expansion o f resources allocated to the education sector, but this has been coupled with a deterioration in basic educational facilities. This indicates one o f the greatest weaknesses in the current budget process -- the lack o f an overall view o f developments and resources in a sector. What is required is a Ministry o f Education covering all levels o f education, which can assess trade-offs between further investment in one area against current expenditure in another. Some o f the objectives o f the reform o f secondary education could well be achieved through the repair and renovation o f existing installations rather than the construction o f new ones. The separation o f the investment and current budgets makes such a choice institutionally difficult. Equally, a choice needs to be made to balance the resources invested in basic education as opposed to specialized secondary education, and on whether it is better to maintain fewer properly equipped schools rather than the existing stock without properly functioning infrastructure and supplies. This i s the basic function o f the budgetary system, which currently is not fulfilled. E. RECENT PROPOSEDREFORMS AND 4.28 Budget preparation and execution problems are being addressed through the development of revised budget preparation procedures and the introduction of a Treasury "Decisionsontheclosingoffacilitiestakeplaceattheoblastandrayonlevelwith theconsentofthecorresponding line ministry. 51 system. The MOF began actively preparingthe Public Finance Reform project in 2001, when the Government began work on a modern Treasury system to replace the current budget execution system. It is recognized that the introduction o f a Treasury system involves a major restructuring o f both the institutions and processes o f budget preparation and execution. As part o f this work, a draft Treasury Law has recently been presented to the Oliy Majlis. Further, the MOF has been working intensively with other institutions to produce detailed plans for the institutional arrangements for a new Treasury system. E.l. BudgetPreparation 4.29 New budget classificationsare beingprepared which would enable evaluation of and accountability in the use of resources. The MOF has also been working on the development o f budget revenue, e~penditure'~and financing classifications to form the basis o f a consistent Chart o f Accounts compatible with GFS 2001, which will be essential for both the revised budget preparation process and the introduction o f the Treasury. Considerable work has already been carried out in the MOF to develop functional, economic, organizational and program classifications. The organizational and program classifications identify the structural unit, the budget beneficiary and the main activity for which budget funding will be used. If this classification is used for the presentation and execution o f the budget (as proposed for 2005), it will allow for clear accountability in the use o f resources by institutions, and provide the Oliy Majlis and C O M with a means to evaluate the budget in a coherent manner. 4.30 A new Budgetpreparation processfor 2005 was developed. The MOF, in conjunction with a U S Treasury advisor, has developed a revised annual budget process within a mediumterm perspective which this PER endorses as a major step forward in reforming the process o f budget preparation. The key elements o f this process are shown in Box 4.5. While not all the changes to the budget process have in fact been adopted for the 2005 budget, the PER urges the Government to adopt them as soon as possible. Box 4.5: The Main Steps Forward in the Proposed Budget Preparation Process The budget is firmly anchored in an explicit macroeconomic and resourceframework. 0 The budget is based on an outlook (over the next three years) for expenditureand revenue on the basis of current policies (for both current and investment spending). 0 The main fiscal policy priorities are endorsed at an early stage (March of the year before the Budget) by the Government. Ceilings are explicitly introduced for budgeting within sectors. The budget is formulated around an organizational classification to enable accountability. The InvestmentBudget, althoughpreparedseparately, is developedin cooperationwith the MOF. 4.3 1 Further reforms will require considerablecapacity building. To deepen the reforms to the budget preparation process, it will be necessary to break up the sectoral ceilings into indicative resource envelopes for the line ministries and the oblasts, for organizations to prepare budgets according to priorities on a programmatic basis. For these changes to have a real effect on the way budgets are prepared, considerable capacity building within line ministries over a period o f years will be required in policy development, priority setting and costing o f policies and measures within a mediumterm perspective. 4.32 The move to a programmatic structure will address the unsustainability of budgeting by economic classification. The practice o f reducing resources by economic classification (e.g. 72 In addition; a database and system of classifying budgetary institutions and activities has been developed so as to allow a budget classification by programs. 52 on maintenance and supplies) is not sustainable as a means o f managingthe budget. It is only when realistic budget plans, including financing for all necessary current and capital spending within a program, are accepted that budgetary policy will become sustainable. To make such choices it will be necessaryto review andremove many of the norms and standards ineach sector to allow the budget holders (Ministries or Oblasts) to fund complete programs and close others73 (including specific institutions). This approach is necessary if the financing reforms for the healthand education sectors are to be workable. E.2. Medium Term BudgetaryPerspective(MTBP) 4.33 A medium term budgetary perspective is a process for determining available public resources and allocating these resources in line with governmentpriorities. It is based on the notionthat the policy decisions made by government should be disciplined by resource realities over the medium term. This should produce sustainable decisions within the annual budgets. The decision to adopt a new policy or make a policy change might require savings and reprioritization in existing policies and programs in order to be accommodated within the aggregatetarget. This requires considerable disciplineand firm proceduresto which all members of the government are committed for the introduction of new policies. This approach is, in principle, well suited to providinga means to implement a Poverty Reduction Strategy (PRSP) such as is proposed to be developed in Uzbekistan.Indeed, internationalexperience has shown that the only meansby which a PRScan be developedand implemented successfully, is when it is properly costed and prioritized, within the known budget constraints, as is the case when a mediumterm budgetaryperspectiveis adopted. 4.34 A MTBP is a wholegovernmentprocess, not a techniqueapplied only in theMOF. The development of the budget in the medium term framework requires the Government to state explicitly and consistentlyits goals and prioritiesin terms of its budget strategy. The adoptionof a MTBP does not mean the adoption of a binding medium term budget. During the Budget preparation process, ministries, agencies and local governments provide estimates of revenues and expenditures for two additionalyears, on the basis of current policies. The process requires close collaborationbetweenthe MOF, line ministries, local governments and the Cabinet. Given the impactofthe MTBP on the overallgovernmentprocess, it will almost certainlytake a number of budget cycles before it can be effectively implemented, and will depend upon the strengtheningofthe annualbudgetprocessfirst. E.3. Budget Execution The Implicationsof The Introductionof a Treasury System - 4.35 The Treasury will allow centralized cash management and smoother execution of the Budget. The Treasury will enable all General Government (central government, local governments and extrabudgetary funds) revenues and expenditures to be managed through a Treasury Single Account (TSA) held at the CBU (a list of Treasury functions is shown in Box 4.6). The Treasury would be responsible for implementing any tax sharing arrangements providedfor inthe Budgetand would issue payment orders when requestedby spending units as long as these were consistent with the Budget appropriationsas determined by the MOF. This system would allow the centralization of cash management, development of robust in-year financial planning, and the possibilityof breakingthe link betweenexpenditures and the regional and seasonal fluctuations of revenue collections. This would bothreducethe costs of borrowing, 73For example, within a particular oblast it might be decided that health services, within the budget available. can be better provided through the opening of a number of properly funded primary clinics while closing a hospital for which there is only sufficient budget for salaries. 53 and reduce the uncertainty regarding the availability o f resources (one o f the main drivers for the fragmentation of the budget). Box 4.6: Main Treasury Functions Functions transferred from the Ministry of Financeto the Treasury: Ex ante control of financial transactionsof central and local government agencies Processingpayment orders inrespect of central government budget expenditure Assessment of monthly expenditure and cash requirements Preparation of monthly government budget execution reports Quarterly reconciliation of expenditure data Preparation of daily and monthly cash flow forecasts for local budgets Management of foreign currency receiptsand payments Domestic debt management Management ofgovernment-guaranteeddomestic debt Maintaining the accounting system Analysis and advice on local government budget execution New functions: Operation of a Treasury Single Account at the CentralBank Comprehensive control by Treasury of all banking operations inthe general government sector Integrated and comprehensiveaccounting by Treasury for all entities of the general government sector Controls of financial managementprocessesin the general government sector Financial planning, Cash management and Commitment control Internal audit (within the Treasury and throughout the general government sector) Publication of annual budget execution reports and financial statements 4.36 An effective Treasury depends on a realistic Budget. The release o f authority to spend should be quasi-automatic provided that the budget is realistic. Strengthening budget preparation is therefore a necessary complement to achieving a satisfactory balance between restraint and flexibility in budget execution. 4.37 The Treasury would permit prompt and relevant reporting. The establishment o f the Treasury, with a single account processing all payments and receipts, allows for consolidated, consistent and rapid reporting o f expenditures and revenues for management and ac~ounting'~ purposes. This will enable policy makers and institutions to respond in a timely manner to changes in the fiscal environment. It would also make possible regular reporting for the public and parliament, and thus enhance accountability and transparency. 4.3 8 Local governments' loss of discretion over payments would be compensated by greater flexibility in budget preparation and greater certainty during budget execution. The Treasury allows the centralized management o f all the funds received and spent by the General Government. To do this it is essential that local Treasury Branches, formed from Oblast and Rayon Finance Departments, should be directly subordinate to the Central Treasury (and thus the MOF), and not to oblast or rayon governments, in order to maximize the treasury's independence and ensure a clear separation o f duties between payment processing and payment origination. The Treasury Branches would then act as agents for executing oblast and rayon budgets. This implies the abandonment o f the current model o f dual subordination o f Finance Departments. This will inevitably lead to a reduction inthe discretionarypowers ofthe oblast governments over the release o f cash but would be offset by greater autonomy in the allocation o f funds as part o f the reforms o f budget preparation. 74Reportingand accounting would initially be on a cash basis, but in time would be possible on a full accrualsbasis. 54 4.39 The Treasury does not mean a loss of autonomy or flexibility for budget institutions. Public institutions, including ministries, agencies and extra-budgetary funds, would no longer hold accounts with commercial banks, but rather would hold these as Treasury accounts upon which they could draw subject to the appropriate authorization. In practice, this would mean, if agreed under budget execution rules, that the funds would be as accessible as if they were in a bank account. The existence o f the Treasury system should not therefore imply a loss o f access to funds, but it does require prior agreement on the rules for access. Concerns that the Treasury system might lead to a very detailed control o f expenditure are also misplaced. In particular, it has been suggested that policies to increase the managerial flexibility o f units within the health sector may be stifled by the Treasury. In fact there i s no essential contradiction. All that i s required is that the appropriation rules (the conditions under which funds can be spent) are properly defined. Thus, a hospital managing a global budget75could be authorized to draw down its appropriation without needing prior authorization on the categories on which the funds would be spent76. Problems will only arise from the application o f inappropriate rules for controlling spending, or the Treasury failing to release funds which have been credited to a Treasury account. 4.40 The Treasury would verifv the regularity of payment orders, but should not exercise discretion on thepayment of validpayment orders. The separation o f payment processing duties from the payment origination duties o f BIs is o f fundamental importance. The Treasury should have wide responsibility for confirming that all the elements o f a payment order are regular, and have the power to withhold payment in the event that irregular payment orders are suspected with good cause. But it is vital that, once the Treasury system begins functioning, the appropriation rules are clear and adhered to. That is, funds for which an authority to spend has been approved should be released without delay or question. Any other arrangement would undermine the credibility o f the Treasury system, generate incentives for budgetary organizations to hold accounts outside the system and would sabotage the potential benefits o f the Treasury system. F. MAINRECOMMENDATIONS F.l. ShortTerm (within oneyear) 4.41 Adoptfully the revised budgetprocessfor the 2006 budget. i) Macroeconomic resource envelope set at the beginning o f the process. ii) MOF issues explicit ceilings to line ministries and requires the preparationo f budgets within those ceilings. iii) PIPshouldbepreparedinclosecollaborationwiththeMOFintheselectionof projects. The budget is formulated around the organizational and programmatic classification and i s presented to the COM and Oliy Majlis in that form. 4.42 The budget, together with documentation on its assumptions and main lines of policy should bepublished. 4.43 TheBudgetSystem Law should be amended.The principal amendments required are: i) To require the enactment o f the budget by the Oliy Majlis. 75 Notdivided by economic classification. 76 The Treasury system would still record the economic categories on which the funds were being spent for reporting and accountingpurposes. 55 ii) To define appropriations as an authorityto spend separatefrom the release ofcash. This is essential for the introductionofthe Treasury. iii) Toestablishtheprinciplethatitiscomprehensiveandincludesrevenuesand expendituresfrom all sources(includingforeignsources). 4.44 No new extrabudgetaryfunds should be created. The existing smaller funds should be reviewed and where possible, re-integratedinto the budget, with funding being made through standardbudget allocations. F.2. Medium Term (one to threeyears) 4.45 Establish a high level committee of the COM responsible for overseeing the budget process andpresenting strategic choices to the COM. Forthe budget processto be effective as a mechanism for allocating resources, it requires guidance from a committee of senior ministers (chaired by the Minister of Finance) which can examine and take responsibility for recommending strategic choices (includingmeasures under a PRSP) to the Government early in the Budget Process. All major policy decisions with an effect on the fiscal situation should be consideredby this committee. 4.46 Extrabudgetaryfunds should be subject to the same rules as the rest of the budget. All EBF's should be put under the aegis of their appropriate sectoral ministry and they should be subject to the same rules for budget preparation, review and audit. In particular, choices on expenditure within the fund, should be subject to questioningfrom both the MOF and the COM as well as the Oliy Majlis. 4.47 EBAs should be limited to the payments for paid services and not allow budget surpluses. The practice of transferring surplus funds to EBAs undermines fiscal control and provides perverse incentives. If funds are unspent at the end of a year these should be reappropriated (if they are deemed necessary) through the normal budget process. If resources are requiredfor bonuses and staff incentives, these should be providedby budget allocations for these purposes. The issue of flexibility should also be dealt with by reducingthe level of control of the MOF on the expendituretables ("smeta") for budget execution. 4.48 Review the norms and regulationsgoverning budget allocations. A review of the legal basis for the operations of ministries and, particularly, the norms and standards for financing institutionsshould be carriedout with a view to eliminatingmany of these and allowing budget institutionsto prepare budgets on a programmaticbasis. 4.49 Reorganization of the MOF. The MOF needsto be restructuredto enable it to perform the core functions of a modern MOF which are: i)to guide the development of macroeconomic policy; ii)develop a sustainable expenditure policy consistent with a stable macroeconomic environment; and iii)to develop options for tax policy which promote the development of the market economy while providing sufficient resources to finance public expenditure. Modern finance ministries typically comprise four or five large departments such as budget, treasury, macroeconomicsand tax policy, which cover the above core functions. The two most important changes proposedare: i) Creationof a macroeconomic analysis and forecastingdepartment within the MOF to be responsible for developingthe macroeconomic basis o f the budget and providing macroeconomic policyadvice to the government. 56 ii) Creation o f one budget department (divided into sectoral divisions) to take a view early in the budget process on the overall resource envelope and to reconcile sectoral demands in order to make recommendations to the Cabinet o f Ministers on feasible budget choices and sectoral trade-offs. 4.50 Multi-year PIPprocess should be reinstated and coordinated by MOF. The choice o f projects within the general government sphere should be coordinated by the MOF as part of an annual and medium term budget process in which PIP priorities are clearly linked to national or sectoral programs. The MOF should be responsible for developing methodology for project appraisal and quality control o f proposed projects. It should also maintain a database o f ongoing projects showing their impact on future recurrent costs, which should be integrated into a wider medium term budget perspective. Once the medium term budget process i s well established (probably after five to ten years) the PIP should simply become an integral part o f this process and not be a separated budgeting process at all. 4.5 1 Transparent operational rules and procedures should be developedfor the Treasury control of budget execution. The rules should allow the Treasury to verify the legality o f payments, but give it no authority to prioritize payments except by rules that are published by the MOF. The rules for managing budget execution should allow different levels of control o f expenditure, and be consistent with sectoral reforms. The rules should also allow access to "own funds" inaccounts for paid services. 4.52 All extrabudgetaryfunds and accounts should be included in the Treasury. Once the Treasury is established, all extrabudgetary funds and accounts should be included in its operations, to ensure effective cash management and proper and prompt reporting and accounting. F.3. LongTerm (over three years) 4.53 Strengthen the role of ministries in policy making and reorganize ministries into a small number of functional based ministries.Line ministries cannot exercise their proper role of being accountable for specific policy areas unless they oversee the institutions in their functional area. Priority should be given to strengthening the role o f the ministries, giving them responsibility for coordinating the budgets o f all the institutions in their policy area. In the long term, a functional review o f all the ministries, state committees and other major agencies is requiredto reorganize them and regroup them under functionally based ministries. 4.54 Reform of the financing of local governments. The current system o f the ad hoc adjustment o f tax rates as part o f a process o f negotiations on expenditure i s both inefficient and non transparent. Ideally, iftaxes are to be shared, tax sharing rates should be fixed (at least for a number of years) and the same across all regions. In order to promote efficiency, regional and local government should either have a degree o f fiscal autonomy or, as is more feasible currently, allocations o f resources from the center, which are determined by a stable and transparent mechanism". This will give oblast governments the flexibility in their budget proposals to deliver services guided by standards and policies set at a national level by the relevant ministry. The reform o f local government finance i s closely linked to the need to abolish dual subordination o f sector departments to local governments and line ministries, by allocating 77These mechanisms may include a combination of equalization grants or subventions (not assigned for a specific purpose. but based upon a transparent formula) and categorical grants which are assigned to local govemments for specific purposes (such as health or education) and are based upon formulas related to the relative needs o f local govemmentsto finance minimum service levels in these sectors. 57 responsibilities for service delivery and reporting to only one level o f government. Reform o f local government finance is necessarily a complex and highly political task (since it involves reassignment o f resources from one locality to another), and is likely to take a number o f years. G. CONCLUSION 4.55 Publicfinance reform must go beyond the MOF.Untilnow the reform has largely been centered around technical developments within the MOF, and indeed commendable progress has been made. However, the analysis here indicates that in the long term much o f the reform o f public finances requires changes outside the MOF, in establishing institutions at the center o f government to coordinate strategic policy choices, to reorganize ministries along functional lines and include under them many o f the state institutions which deal directly with the MOF. New budgeting processes and the establishment o f the Treasury will, o f course, require work within the MOF. However, one o f the main tasks now for the MOF is to make the case to the Government and public institutions for the need for reforms and the long term benefits that will ensue. 58