Report No. 28123-KG Kyrgyz Republic Public Expenditure Review Fiscal Policies for Growth and Poverty Reduction (In Two Volumes) Volume II: Reform Priorities and Sector Strategies March 22, 2004 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank CURRENCY AND EQUIVALENT UNITS (as of March 22,2004) Currency Unit =Som US$1= 42.80 Som WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank O&M Operations and maintenance CDF Comprehensive Development OECD Organization for Economic Framework Cooperation and Development CG Categorical grants PC Paris Club EBRD European Bank for Reconstruction PEM Public Expenditure Management and Development PIP Public Investment Program EDF Economic Development State Fund PPI Producer Price Index EIRR Economic Internal Rate of Return PPP Purchasing Power Parity EU European Union PSOS Public Service Obligations FGPs Family Group Practices PTUs Professional Technical Schools FSU Former Soviet Union RADS Rural Advisory Development GDP Gross domestic product Service I&D Irrigation and Drainage RCLAR Republican Center for Land and IDUs Intravenous Drug Users Agrarian Reform IGIAs Intergovernmental Irrigation SCI State Customs Inspectorate Agreements SCPFI State Committee for Property and IMF International Monetary Fund , Foreign Investments IMR Infant Mortality Rate SES Sanitary Epidemiological KAJ Kyrgyz national airline Services KR Kyrgyz Republic SMEs Small and Medium Enterprises MAWR Ministry of Agriculture and Water SMESP Small and Medium Enterprise Resources Support Fund MEC Ministry of Education and Culture SMRF State Material Reserve Fund MHIF Mandatory Health Insurance Fund SOEs State-Owned Enterprises MMR Maternal Mortality Rate SPF State Property Fund MoF Ministry of Finance STI State Tax Inspectorate MOH Ministry of Health TB Tuberculosis MOLSP Ministry of Labor and Social TDMHIFs Territorial Departments of the Protection MHIF MOTC Ministry of Transport and UMB Unified Monthly Benefits Communications UNDP United Nations Development NGOs Non-governmental Organization Programme NPV Net Present Value VAT Value Added Tax NSPR National Strategy for Poverty WUA Water User Association Reduction Vice President: ShigeoKatsu (ECAVP) Country Director: Dennis de Tray (ECCUS) Sector Director: Cheryl W. Grey (ECSPE) Sector Manager: Samuel Otoo (ECSPE) I Task Team Leader Pedro L. Rodriguez (ECSPE) ACKNOWLEDGMENTS This report was prepared by a group of the World Bank staff and consultants led by Pedro L.Rodriguez and composed of Azamat Abdymomunov, Natalia Pisareva, Luis Alvaro Sanchez, Ekaterine T. Vashakmadze, (Fiscal and Economic Framework, overall report); Alexander Morozov (Public Investments); Sarbani Chakraborty, Joseph Kutzin,' Jan Bultman, and Dinara Djoldosheva (Health), Jacques Yenny, Richard Podolsky (Transport); Jana Orac (State Employment and Compensation), Rashid Faroque (Agriculture and Irrigation), Michael Mertaugh (Education), Verdon Staines (Pensions), Dana Frey2 (Revenue Administration) and Dan Mullings (Intergovernmental Finance). Valuable comments and guidance were received from Jit Gill, and Alma Kanani (Governance Structural Adjustment Credit), Sebnem Akkaya (Executive Summary) and Joop Stoutjesdijk and Gotz Schreiber (Agriculture). Peer reviewers were Richard Allen andVinaya Swaroop. The Kyrgyz authorities assisted inthe preparation of this report during the course of a mission in March 2002. The team is particularly grateful to MessrsMmes.: Kanimetov, Komarover (Economic Policy Department, President's Administration); Abildaev, Toromorozaev, Aaliev, Mambetjanov, Azykov, Mukambetov, Ibraimova, Baigonchokov, Rysalieva, Sabirova, Temirbekov (Ministry of Finance), Shadiev, Kasymaliev (Revenue Committee), Jumaliev, Imanaliev, Borunbaeva, Miyarov, Moldobaev, Svirodova (Ministry of Transport and Communications), Omurkulov (Railway Department, Ministry of Transport and Communications), Muratov, Abakirov (Civil Aviation Department, Ministry of Transport and Communications); Meimanaliev, Mukeeva, Madybaev, Karakulov (Ministry of Health Care); Abdullaeva, Kaibaliev, Kobesheva (Ministry of Labor and Social Protection); Ilyasova, Matanov, Abduganiev, Shamkeev (Ministry of Agriculture, Water Resources and Processing Industry), Jeenbekov, Makarov, Bakirov (State Committee for State Property and Direct Investments) and Boldjurova, Djumagulova, Djunusova (Ministry of Education and Culture). The World Bank team also receivedvaluable support from staff inthe National Bank of the Kyrgyz Republic, the National Statistical Committee, and the Ministry of Agriculture. The report builds on the following background papers: (1) Socium Consult: Kyrgyz Republic Review of Public Funding of Health Sector, July 2002; (2) WHO Working Papers on Health Issues in Kyrgyzstan, Various by Joseph Kutzin (WHO Sr. ResidentAdvisor for the Manas Health Policy Analysis, Fundedby DFIDAJK);(3) Dan Mullings, Intergovermental Finances and Reform in the Kyrgyz Republic, June 25, 2002; (4) World Bank, Kyrgyz Pension Policy Note, July 2002. Thefindings of this PER are complemented by a recently produced Country Procurement Assessment Review, and Country Financial AccountabilityAssessment. 'Joseph Kutzin was the WHO Sr. Resident Advisor for the Manas Health Policy Analysis, funded by DFIDKJK. Dana Frey was the Senior fiscal resident advisor under a USAID sponsoredproject. The views reflected hereare those ofMr.Frey andthe World Bank and do not necessarilycorrespondto those ofUSAID. An earlier version of the Executive Summary of this report was discussedduring the Consultative Group Meeting held in Bishkek, October 9-11, 2002. PER has been discussed with the President Administration in July 2003, as well as with the Revenue Committee. The chapters on health and education were discussed with government authorities as well as with key Parliamentarians. 11 * . TABLE OF CONTENTS 1 ENHANCINGREVENUE GENERATION . ........................................................... . . 1 A. INTRODUCTION B. BACKGROUNDTHE SYSTEM................................................................................. 4 ......................................................................................................... 1 TO C. THEREVENUE SYSTEM OF THE KYRGYZ REPUBLIC.................................................. 5 2.DREMOVING . CONCLUSION AND FUTUREAGENDA...................................................................... 16 CONSTRAINTS TO RESOURCE MANAGEMENT .................21 A. INTRODUCTION ....................................................................................................... 21 B. EXTRABUDGETARY FUNDSAND OFF-BUDGET TRANSACTIONS .............................. 24 ......................................................................... 30 D CONCLUSION AND FUTUREAGENDA...................................................................... C. FRAGMENTATION THE BUDGET . OF 33 3. STREAMLINING STATE EMPLOYMENT AND IMPROVING COMPENSATION POLICIES ...................................................................................... 34 A. INTRODUCTION ....................................................................................................... 34 B. EMPLOYMENT REMUNERATION AND ...................................................................... 34 49 4.C ORGANIZATIONAL REFORMS........................................................................ . CONCLUSION AND FUTURE AGENDA...................................................................... 51 A. INTRODUCTION B. ....................................................................................................... 5 1 SERVICE DELIVERY SELECTED INSTITUTIONS 52 .................................................... C. . TRANSPARENCY ACCOLINTABILITY................................................................. IN AND 55 56 5.DHEALTH.................................................................................................................. CONCLUSION AND FUTUREAGENDA...................................................................... 58 A. INTRODUCTION ....................................................................................................... 58 B. c. STRENGTHSAND HEALTH STATUS ..................................................................................................... 58 ...........60 E. D. REFORMSINFINANCINGAND DELIVERYOFHEALTH WEAKNESSESOF THE INHERITEDHEALTH CARESYSTEM SERVICES............................. 62 HEALTH EXPENDITURES ......................................................................................... 66 6.F . RECOMMENDATIONS .............................................................................................. 73 EDUCATION ........................................................................................................... 77 A. INTRODUCTION ....................................................................................................... 77 B. TRANSITION CHALLENGES...................................................................................... 77 81 D. C. PERFORMANCEOFTHEEDUCATION SYSTEM ......................................................... MANAGEMENT ANDFINANCINGOFEDUCATION ................................................... 85 87 7.E SOCIAL . CONCLUSION AND FUTUREAGENDA ...................................................................... PROTECTION ........................................................................................ 98 A INTRODUCTION AND BACKGROUND ........................................................................ 98 B..EVALUATINGCURRENTSOCIAL POLICIES AND EXPENDITURES ............................ 105 C. OPTIONS AND RECOMMENDATIONS ...................................................................... 111 ... 111 8. THE TRANSPORT SECTOR .............................................................................. 113 A. THETRANSPORT SECTOR TODAY......................................................................... 113 B PUBLICEXPENDITURESTRANSPORT IN ................................................................. 120 124 9.C AGRICULTUREAND .. CONCLUSIONAND FUTUREAGENDA.................................................................... IRRIGATION ............................................................... 130 ...................................................................................................... 130 B. PUBLIC EXPENDITURE AGRICULTURE IRRIGATION A. BACKGROUND IN AND C . ................................... 130 KEYISSUES .......................................................................................................... 137 D. CONCLUSIONAND FUTURE AGENDA.................................................................... 149 ANNEXES ...................................................................................................................... 152 ANNEX 1: WAGESYSTEMS....................................................................................... 153 A"EX 2: PAYAND EMPLOYMENT MODEL ............................................................... 155 MAP ................................................................................................................................ 163 Index of Tables Table 1.3: ComparativeRevenueCollection Performance,SCI/STI and Social Fund, 1996-2001...............7 Table 1.2: Tax Collections inthe Republican and Local ConsolidatedBudget, 2001 ................................... Table 1.1. Kyrgyz Republic: Medium Term Fiscal Framework. Main Results.2001-07 .............................. 1 5 Table 1.4: Characteristicsof Revenue Collection Agencies, as Approved inthe 2002 Budget..................... Table 1.5: Number of Contributors to the Social Fund, 1999-2002............................................................... 8 Table 1.6: Arrears by Tax, 1995-2001......................................................................................................... 11 9 Table 2.1: Expenditure Allocation by Level of Governmentand ExtrabudgetaryFunds, 2001 ..................23 Table 3.1: Budget-fundedCivilianGovernment Employees,2001.............................................................. Table 2.2: Revenue and Expenditure from SpecialMeans, 1999-2001....................................................... 31 35 Table 3.3: Summaryof Sample Model Scenarios for Civil Service............................................................. Table 3.2: Monthly Earnings for Selected MinistryPosts............................................................................ 42 Table 5.1: Main Health Status Indicators for the Kyrgyz Republic, 1991-2001.......................................... 45 Table 5.2: Trends in SelectedCommunicable Diseases, 1991-2001............................................................ 58 Table 5.3 : Hospital Capacity andUse inthe ECA Region........................................................................... 59 Table 5.4: Contribution Sources for the MHIF ............................................................................................ 63 61 Table 5.5: The Basic Features ofthe Single Payer System.......................................................................... Table 5.6: Public Spendingon Health in Relation to GDP, 1995-2001....................................................... 64 Table 5.7: Health Expendituresby Source, 2000-01.................................................................................... 67 Table 5.9: Revenue Transfersto the MHIF from the Social Fund and Republican Budget, 1997-2001......68 Table 5.8: Local and Republican Shares of State Budget Health Spending, 1995-2001.............................. 68 Table 5.10: Distributionof State Budget Health Spending, by Program, 1995-2001.................................. 69 Table 5.11: Distributionof State Budget Health Spendingby Category, 1995-2001.................................. 71 Table 6.1: Ethnic Composition and Ruralmrban Status of Population by Oblast........................................ 72 78 Table 6.3: Grade 1-11Gross Enrollment Ratios by Oblast, 1999/2000....................................................... Table 6.2: Enrollments by Level, 1992/93-2000/01..................................................................................... 81 82 Table 6.5: Deployment of Schools and Teachers by Oblast, 1997............................................................... Table 6.4: Fifth-Grade Assessment Results inNumeracy by Oblast, November 2000................................ 83 Table 6.6: Intensity of Teacher Use by Oblast, 1997................................................................................... 84 Table 6.7: Public Expendituresfor Education as a Share ofTotal Public Expenditures, 1990-2001...........84 89 Table 6.8: Public Expenditureson Education, Kyrgyz Republic and Selected Comparator Countries, 1997 ............................................................................................................................................................. Table 6.9: Sourcesof Financing for Primary School Expenditures............................................................. 89 Table 6.10: Average Monthly Earnings in2001 by Sector .......................................................................... 91 92 Table 6.11: Teaching-Hour RequirementsinPrimary Education, Kyrgyz Republic and Selected ComparatorCountries.......................................................................................................................... 93 iv Table 6.12: EducationBudgets by Source. 1999and 2000.......................................................................... 94 Table 6-13: ConsolidatedEducationExpenditures(Republican Budget +Local) Expendituresby Level ofEducation, 1998.......................................................................................... 97 and Per Student Table 7.1 Kyrgyz Republic, Social Expenditureof ConsolidatedGeneral Government 1995-2001(1,2), (as Table 7.2: Decomposition of PensionSpending, Pensioners, PensionFund............................................... share o f GDP) .................................................................................................................................... 102 Table 7.3: Budgetary Social ProtectionExpendituresand Quasi-fiscal Price Subsidiesfor Energy, 1995 -103 2001 (Inpercento fGDP) ................................................................................................................. 104 Table 7.4: Table 8.1: Classification of Roads by Function, 2002 ............................................................................... Impact of Pensions on Poverty RiskAmong the Overall Population........................................ 107 Table 8.2: Classification of Roads by Type of Surfaceand Width, 2002 .................................................. 113 Table 8.3: Length of Roads under Maintenance, 1997-2006..................................................................... 114 Table 8.4: Vehicle Registration Numbers.................................................................................................. 114 117 Table 8.5: Kyrgyz Republic: Transport Sector Expenditures, 1999-2002 ................................................. Table 8.6: Kyrgyz Republic: Ministry ofTransport Budget, 1999-2002.................................................. 121 122 Table 8.7: ComparativeMaintenanceBudgets for Countrieswith Similar Networks and Lower GDP per Table 8.8: Kyrgyz Republic: Freight and PassengerTransport, 1990-2001............................................... Capita................................................................................................................................................. 125 127 Table 9.1: Evolutiono fPublic Expenditure(Actuals) in Agriculture, Water Supply Organizations, Forestry, Fishing, and Hunting, 1990-2001....................................................................................... 131 Table 9.2: Extent of EuropeanUnion Support for the Agriculture and Irrigation Current Budget, 1997- Table 9.3: Domestic Spendingby MAWRby Departments, 1997-2001................................................... 2001 ................................................................................................................................................... 132 Table 9.4: Economic Composition ofTotal Expenditure, 1997-2000........................................................ 133 Table 9.5: Economic Composition ofTotal Expenditure, 1999-2001........................................................ 134 135 Table 9.7: Plannedand Actual Releaseof Fundsto Investment Projects, 1999-2001............................... Table 9.6: Public InvestmentPrograminAgriculture ................................................................................ 136 Table 9.8: Expenditure on RADS, 1999-2001........................................................................................... 138 137 Table 9.9: ResearchExpenditure by Institute, 1995-2001......................................................................... Table 9.10: Total ResearchExpenditure and Share ................................................................................... 139 139 Table 9.12: Public Expenditure on Seed, 1997-2001................................................................................. Table 9.11: Canal Systems in Neighboring Countries ............................................................................... 145 Table 9.13: Grants for Input Purchases...................................................................................................... 147 148 Index of Figures Figure 1.1: Relationship of Tax Revenue and Income in SelectedECA Countries ....................................... 2 Figure 2.1: Implementation of Spendinginthe State Budget andthe PIP, by Function, 2000 .................... Figure 1.2: Tax Collections as aPercent of GDP, 1995-2001........................................................................ 4 22 Figure 3.2: Employment by the Republic and Local Governments, 2001.................................................... Figure 3.1: General Civilian GovernmentEmployment as Percento fPopulation....................................... 36 Figure 3.3: Local GovernmentEmployment by Sector, 2001...................................................................... 37 Figure 3.4: MinistryEmployment, 2001...................................................................................................... 37 Figure 3.5: Base Salary as PercentofTotal Earnings.................................................................................. 38 Figure 6.1: Evolutionof Real GDP, 1990-2000 .......................................................................................... 80 Figure 5.1: Health Capacity Reduction in Chui and Issyk-KulOblasts, 2001 ............................................. 41 65 Figure 7.1 Simulation ofthe Share ofEach Componentinthe Calculation for New Benefits inthe Future ........................................................................................................................................................... 100 Figure 7.2: Kyrgyz Republic: Evolutionof DirectSocial Spendingand Implicit Social Subsidies, 1995- Figure 7.3: Kyrgyz Republic-Composition of Social Spending, 2001 ....................................................... 2001 ................................................................................................................................................... 104 105 Figure 7.4: Risk of Poverty and Amount of Poverty Gap Covered by PensionBenefit (by IncreasingLevel Figure 8.1: Kyrgyz Republic: Ministry of Transport HeadquartersOrganization Chart........................... of Pension)......................................................................................................................................... 108 Figure 8.2: Kyrgyz Republic Ministry o fTransport Operating Departments ............................................ 128 129 V Index of Boxes Box 1.1: A DiagnosticFrameworkfor RevenueAdministration................................................................... Box2.1: KyrgyzRepublic:Off-budgetGrants from the JapaneseGovernment. 2001................................ 3 Box2.2: Kazakhstan:Experiencewith ReportingForeignFinancedProjectsinthe Treasury.................... 28 Box 3.1: Sequencingo f Civil Service Pay andEmploymentReforms:The Albanian Case........................ 29 Box4.1: ReformingPublic Sector Institutions: The LatvianExample....................................................... 47 57 vi 1. ENHANCINGREVENUEGENERATION3 A. INTRODUCTION 1. The Challenges. The medium-termframework for the Kyrgyz Republic will rely heavily on revenue gains if further sharp reductions in spending are to be avoided (Table 1.1). These gains are to come from both tax and non-tax revenues. Tax collections need to be raisedby about three percentage points o f GDP by the year 2007 (about 0.5 percent a year), on the basis o f both administrative and tax policy measures. In view o f the overestimation o f revenues and the government's dissatisfaction with the current structure o f the revenue system, a strong package o f revenue administration and policy reform i s needed. Non-tax revenues are to increase, mainly by incorporating into the budget the revenue from intergovernmental irrigation agreements (IGIAs). These arrangements are, however, deficit neutral, since the power and district heating sectors that currently use these revenues will need them up to the point at which prices reach cost-recovery levels (which is expected to take another two to three years for power and much longer for district heating). Inaddition, fees are expected to be overhauled, and this may well result intheir overall reduction. However, fees would be increased with greater cost-recovery for O&M inirrigation. Table 1.1: Kyrgyz Republic: Medium Term FiscalFramework, Main Results, 2001-07 ZOO1 2002 2003 2004 2005 2006 2007 Total revenueand grants 20.3 20.9 23.5 23.2 23.3 23.6 23.5 Total revenue 19.5 19.9 22.4 22.6 23.0 23.3 23.2 Current revenue 19.4 19.9 22.3 22.6 23.0 23.3 23.2 Tax revenue 15.8 16.4 17.0 17.4 17.8 18.2 18.3 Incomeand profit taxes 2.7 2.6 2.7 2.8 2.9 3.1 3.2 VAT 5.7 5.8 5.9 6.0 6.0 6.0 6.0 Excises 1.5 1.7 1.8 1.8 1.9 2.0 2.1 Customs 0.4 0.4 0.5 0.5 0.5 0.6 0.7 Land tax 0.3 0.3 0.4 0.5 0.6 0.7 0.8 Road and Emergency Fund 1.3 1.4 1.3 1.3 1.3 1.1 0.8 Other 0.5 0.7 0.8 0.9 1.o 1.1 1.1 Payroll tax 3.3 3.5 3.6 3.6 3.6 3.6 3.6 Nontax revenue 3.7 3.4 5.3 5.2 5.2 5.1 4.9 Profit ofNBKR 0.4 0.4 0.4 0.4 0.4 0.4 0.4 Didivends from stock companies 0.5 0.5 0.4 0.3 0.3 0.3 0.2 Consessionpayment from "Kumtor" 0.3 0.2 0.2 0.2 0.2 0.2 0.1 Paymentsfor services 1.9 1.8 1.8 1.9 1.9 1.9 1.9 state fees 0.2 0.2 0.2 0.3 0.4 0.4 0.4 special means 1.7 1.6 1.6 1.6 1.6 1.6 1.5 Other non-tax proceeds 0.5 0.5 0.5 0.5 0.5 0.5 0.5 Other non-tax proceeds (SF) 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Electricity export revenues 0.0 0.0 2.0 1.9 1.8 1.7 1.7 Caoital revenue 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Grants 0.8 1.0 1.1 0.6 0.3 0.3 0.3 Source: WB staff estimatesbasedon data from the MoF, the Social Fund, and the State EnergyAgency. This report was printedin 2004 for informationpurposes, without any major update on data, analysis or recommendations. It should be mentioned that many of the recommendations made (e.g., in revenue administration) have been adopted by the authorities and are under implementation. The original policy matrix was replaced by a piece which integrates recommendations made by the three key pieces of economic and sector work in the area o f public finance (e.g., this PER, the Country Procurement Assessment, and the Country Financial Accountability Assessment), and the support provided by the Bank's Governance StructuralAdjustment Credit. 2. The challenge i s larger than it appears. First, revenues inthe Kyrgyz Republic (at about 16 percent o f GDP, after social security contributions), are already consistent with the country's low income level, its output structure (about 40 percent of value added comes from incipient agriculture), and its limited administrative capacity (Figure 1.l).4 Second, tax revenues in the Kyrgyz Republic are in fact lower than they appear, given that there are still substantial offsets andbarter transactions incollections. Figure 1.1: Relationshipof Tax Revenue and Incomein SelectedECA Countries -EE a 46 I Belarus 41 A I Bosnia*- .=] 36 31 L Uzbekistan 'Ukfa R u s s w Macedonia But aria Romania -gE s 3 26 21 MoldovO Albania. Kazakhstan 16 KR/+ Armenia g * I 11 Azerbaijan* Georgia I 5.0 5.5 6.0 6.5 7.0 7.5 8.0 GNI per capita Athlas method (current US%) Sources:RecentEconomicDevelopments,IMF; World DevelopmentIndicators,WB staff calculations. 3. The Strategy. This chapter advocates a two-pronged strategy for raising revenue. First, better means should be provided to the revenue authorities by launching a program for the rationalization and modernization o f revenue collection institutions. Such a program must be comprehensive; it must encompass investments in human capital (training, compensation, and a stringent hiring policy) as well as in the necessary minimum hardware-hardware that would reduce decisions made on the basis o f individualjudgments and client-tax officer contacts to the maximum extent. The program should also substantially rationalize the existing infrastructure for revenue collection, beginning at the level o f institutions but also reaching branches and possibly staff,; it should revamp budget procedures for revenue collection agencies. A revenue collection modernization program would probably allocate about US$15 million to the public investment program. The exact amount, however, should be developed in the context o f preparing a comprehensive assessment-with donor assistance-along the lines described in Box 1.1, specifically identifying both the scope and the costs o f the modernization. 4. Second, a series o f simplifications o f tax policy, base expansions, and assignment of taxes to local governments should be launched that would be designed to induce IfGDPinpurchasingpowerparity(PPP)U.S.dollarswereutilizedasameasureofincome,theKyrgyz Republic would be below the regression line, Le., its level of tax revenue would be much lower than requiredbythe incomelevel(see Annex 1). 2 greater compliance. Following the government's objectives, these simplifications would include: phasing out turnover and other "nuisance" taxes and further reducing payroll taxes; compensating for lost revenue by expanding the tax base through such measures as extending the value added tax (VAT) to products that are currently exempted; and reconsidering special exemptions for certain categories o f imports and entities. In addition, incentives for compliance would increase through the assignment o f revenues to local governments, along with the responsibility for their collection and accountability to their local taxpayers. This would begin with a tax on immovable property and would continue through a restructuring o f all local taxes. On the taxpayer side, the 2001 reductions in the rate o f corporate, income, and payroll taxes should facilitate compliance. This must follow a better-developed allocation o f functional responsibilities and expenditure assignment, combined with an alignment o f incentives to maximize the collection o frevenues. Box 1.1: A Diagnostic Framework for Revenue Administration Traditionally, the approach to the modernization of tax and customs administration has focused on: tax policy and tax laws; the streamlining of basic technical processes, such as taxpayer registration, processingof returns and payments, tax audit and border operations; computerization; the reorganization of tax departmentson functional lines; the creation of Large Taxpayers Units; and technical training. This approach, as comprehensive as it sounds, may fail to fully uncover the underlying causes of institutional and organizational dysfunction, leadingto partial solutions and sub-optimal outcomes. More recently, various countries, including Jamaica, Colombia, and others, have developed an approachbased on a comprehensivediagnostic analysis of revenue administration. This would take into account, in an integratedmanner, both the traditional areas of focus as well as non-traditional areas such as the array of environmental factors that impinge on the Revenue Administration (RA); the effect of the history of the RA on its current and future functioning; organizational strategy; organization and management functions; and informal culture. For a description of the integrated approachto tax administration, see Jit B. S. Gill, World Bank Technical Paper No 472, June 2000. 5. These investments and policy efforts would bring results, as there is ample room for improving the efficiency o f revenue collection. This should lead to higher revenue either by reducing leaks in the system (Le., the difference between amounts paid and amounts collected) or by expanding the tax base as the various measures facilitate business development. Reforms o f the revenue collection system should also be directed to improving compliance and to facilitating business compliance. Such improvements, when effectively obtained, could prove central to promoting small and medium enterprise development. 6. The revenue gains from the modernization would have to be sufficient to reduce the fiscal deficit over the mediumterm. This, inturn, will eventually allow a reduction in certain taxes and contributions, to pay timely VAT reforms, and to put an end to reliance The costs and impediments that revenue collection agencies impose on business development have by now been well studied. See, for example, World Bank, "Governance and Service Delivery in the Kyrgyz Republic," Draft of July 2002; and USAID ARD/Checchi, Regulatory and Business Environment Survey, December2000. 3 on tax advances. The sequencing is, therefore, important: to launch the modernization program first and to reduce rates only as the program shows improvements incollections. B. BACKGROUND THE SYSTEM TO 7. After an initial successful tax reform inthe early to mid-l990s, recent history has been marred by an inability to further build on this reform, leaving the system at an embryonic stage. The administrative structure consists o f uncoordinated fragments, split among four relatively autonomous agencies: (i) State Tax Inspectorate (STI); (ii) the the State Customs Inspectorate (SCI); (iii) Social Fund Collection Department; and (iv) the the Financial Police. Fundingfor the system i s not fully accountable through the regular budgetary process because o f special means or off-budget revenues. Functional assignments are duplicative, with conflicting and contradictory incentives among agencies administering the system. 8. Together, these problems have frustrated the government's efforts to modernize tax administration and have contributed to stagnant collections as a percentage o f GDP since 1996 (see Figure 1.2). Widespread tax evasion and chronic budgetary shortfalls are two primary consequences o f these inefficiencies. This lack o f an efficient service- oriented tax administration has ledto the underprovisiono f public goods; it has frustrated attempts to foster investment (domestic and foreign), and contributes to poor economic growthinthe Kyrgyz Republic. Figure 1.2: Tax Collectionsas a Percentof GDP, 1995-2001 '16.0% i 14.0% :12.0% 10.0% 0 c, 8.0% C 6.0% p" 2 4.0% 2.0% 0.0% I 1995 1996 1997 1998 1999 2000 2001 9. Efficient and effective tax systems rely on both voluntary and forced compliance by taxpayers. While minimizing the need for intrusion into economic activity, a proper tax administration reduces the burden o f the collection mechanism. It does so by becoming a service-oriented system of informed compliance, assisting taxpayers to follow the rule of law. Inthe Kyrgyz Republic, the system i s highly intrusive and relies disproportionately upon coercion to meet quotas. The system also hampers efforts toward fiscal decentralization and sustainable economic growth. Assignments and lines o f control should be clear-cut; information should be readily available; interagency conflict and ambiguity should be minimized. As such, optimal integration o f various agencies, open dialogue on taxes and taxpayer education, and a tax policy driven by economic 4 principles are all needed before a significant level o f tax administration modernization, efficient fiscal decentralization, and the resultant economic growth can be fully realized. 10. The 2001 Tax Reform Conception was initiated and enacted by Parliament and signed by the President in the summer o f 2001. It set out the objective o f the modernization o f the tax system, with administrative reforms, including agency consolidation, providing in large part the necessary revenue to fund this modernization. It also called for the repeal of the Soviet-style turnover taxes (widely held to be barriers to investment and growth), a reduction in the tax rates on labor and capital, and the simplification o f the system o f taxation for small businesses. Unfortunately, the lack o f coordinated efforts on the part o f the fragmented tax administration agencies, conflicting interests, and a myopic tax policy-mainly driven by revenue crises-have to date hampered any substantive move to further modernize the tax system. c. THEREVENUE SYSTEM OFTHE KYRGYZ REPUBLIC 1. Overview 11. An important characteristic of the tax system in the Kyrgyz Republic is its reliance on taxes collected at the republican level and, more specifically, consumption taxes: VAT, turnover, retail sales, and excises. Together, these revenues account for two- thirds o f total consolidated budget revenues, excluding Social Fund revenues-a higher share than inmost transition economies (Table 1.2). Table 1.2: Tax Collectionsinthe Republican and Local ConsolidatedBudget,2001 ~~~ As percent of Tax Million som Tax revenue GDP Individual incometax 960.9 10.5% 1.3% Corporateprofits tax 993.7 10.8% 1.3% VAT 4,22 1.4 46.0% 5.7% Retail sales 305.1 3.3% 0.4% Excise tax 1,102.6 12.0% 1.5% Road(turnover) tax 409.5 4.5% 0.6% Emergency(turnover) tax 580.3 6.3% 0.8% Minerals tax 24.8 0.3% 0.0% Land tax 208.7 2.3% 0.3% Customsduties 301.4 3.3% 0.4% Other taxes 78.0 0.8% 0.1% Total taxes 9,186.6 100.0% 12.4% Social Fund payments 3,256.0 4.4% Ofwhich paid by government " 848.9 1.1% Republicanbudget subsidy 397.9 1/ Paid by local or republican agencies on behalf of their employees. Subsidy is a direct paymentto prevent a deficit. Sources: Ministry of Financeand Social Fund. 12. The Kyrgyz Republic levies a total o f 24 taxes, excluding Social Fundpayments. All o f the taxes and contributions are collected by the central government. However, the ownership o f taxes varies. Of these taxes, five are owned exclusively by the republican 5 budgetY6three are shared betweenthe republican and sub-national governments, and 16 self-governments and local state administration^.^ These taxes vary inrevenue yield and are retained exclusively for the use o f sub-national governments, including both local complexity, from a tax on growing flowers ingreenhouses-which discourages growth in a potential industry-to a comprehensive VAT, close to EU6`h Directive standards.' 13. Local taxes accounted for 14 percent o f local revenues in 2001, almost all o f which was due to the retail sales and land tax revenues. The rural land tax was earmarked for ail okmotu, or villages, beginning in2002; the retail sales tax i s often used by both rayons and oblasts to fund services. Most other taxes are o f the nuisance category, such as a dog tax, a tax on flowers grown in greenhouses, and a tax on the use o f local symbolism. Intotal, there are eight taxes that yielded less than 1 million som in 2001, Furthermore, local governments, both local state administrations and local self- governments, have little control over tax rates, with land tax rates being set by the national government. This absence o f own-source revenues will increasingly become an impediment to further fiscal decentralization as actions are taken to assign more expenditure responsibility to sub-national governments. 14. The structure o f revenues influences administration. The corporate and personal income taxes are shared with sub-national governments; this arrangement, and the correspondingly lower amount o f revenues received from these taxes, has resulted in fewer resources being assigned to their administration and to compliance enforcement. This, in turn, creates a vicious circle o f low collections and low enforcement. The number o f taxes also strains administrative capacity. Each tax requires a separate collection procedure, additional taxpayerhax official contact, and separate accounting and bookkeeping. It i s likely that many taxes do not raise sufficient revenue to exceed their administrative costs. 15. Administrative Structure. The revenue system is administered by four separate agencies: the Collection Department o f the Social Fund, the STI, the SCI, and, in an Department o f the STI and SCI auditor^.^ Each of the three revenue-collecting agencies oversight role, the Financial Police, an agency created from the former Tax Police i s assigned a tax or a set o f taxes. The SCI collects VAT," excise taxes, and customs duties or fees on imports. The Social Fundcollects the employer and employee share o f the social taxes' (earmarked for social security, pensions, unemployment insurance, and As a pilot project in the 2002 budget only, VAT was shared with ail okmotu (villages) in some areas. The tax total also does not include nationalduties or customs duties. National taxes include: VAT, road, emergency, and minerals taxes, and customs duties. Shared taxes include: individual income, corporate profits, and excise taxes. Local taxes include: land, health resort, advertising, dog owners, auctions and lotteries, parking, symbolism, refuse, flowers, hotel, hunting and fishing, tourists leavingCIS, video saloons and concerts, retailsales, unusedpremises, andtransportation. The Kyrgyz Republic has a single, 20 percent rate, VAT, with agricultural produce and energy the only major exemptions. Exports of goods are zero-rated, except for gold. There is a 300,000 som annual thresholdbeforeregistrationis required. Presidential Decree #363 of 28 December 2000 "On Reorganization o f State Agencies"; Government resolution#76 of 3 March2001 "On settingup the FinancialPoliceunderthe Ministry ofFinance." lo Beginning in January 2001, the Kyrgyz Republic adopted a destination principle for VAT with all countries. "Socialsecuritytaxesare,themselves,acombinationofapayrolltaxfortheformalsector,alandtaxfor the agrariansector, and a patent system for micro-enterprises. 6 medical insurance), while the STI i s responsible for collecting the remaining 22 taxes, including, on behalf o fthe sub-national governments, local taxes. 16. Since 1996, revenue collections by the STI and SCI have remained stagnant, while those of the Social Funds have dropped since 1999, even though there was no change inthe contribution rates (Table 1.3). Table 1.3: Comparative RevenueCollectionPerformance, SCVSTI and SocialFund, 1996-2001 1996 1997 1998 1999 2000 2001 State Tax Inspectorate and State Customs Insuectorate 12.7 12.5 14.2 12.3 12.3 12.4 Social Fund,'collections from entities other- than the 4.6 4.2 4.2 3.6 3.3 3.3 budnet Note: Contribution rates. 17. The STI, the SCI, and the Financial Police report to the Deputy Minister for Revenues at the Ministry of Finance. The Social Fund i s a separate agency, with the director holding the rank o f minister. This position was somewhat downgraded in the 2001 administrative reforms, when the responsibility for the pension policy was given to the MinistryofLabor and SocialProtection.12 18. Together, these agencies employ about 6,400 people. Table 1.4 shows the staff, number o f offices, and budget for each o f these agencies, along with the estimated revenue collections. Compensation within each agency is extremely low, following a pattem found throughout the government. According to documents submitted with the 2002 budget, the average net monthly salary will be 2,500 to 5,000 som in each of the agencies, even though some progress has been made to increase salaries in the past two years. These low salaries virtually require employees to supplementtheir income through outside employment or other compensation. This leads to high tumover within the agencies inthe skilled positions, andthis i s often seen as an open invitation to corruption. 19. Each agency has a main administrative office in Bishkek and regional offices that carry out most of the tax or revenue collection procedures. Together, the three collection agencies have a total o f 240 branch offices. Because o f their number and geographical distribution, combined with a limited communication system, a low capacity for conducting training, and a low level o f computerization, individual offices are hampered intheir attempts to follow consistent policies. Consequently, law or procedure changes can take weeks to be disseminated. '* Inaddition, other agencies also collect revenues; the State Fund for Economic Development employs 160 people and collects approximately 180million som in revenues from loan repayments to the budget. 7 Table 1.4: Characteristicsof RevenueCollectionAgencies, as Approved in the 2002 Budget No. of Total Budget FromSpecial Number Collections Employees (million som) Means(YO) of Offices (millionsom) State Tax Inspectorate 2,732 133 32.6 62 5,865 State Customs Inspectorate 1,576 128 62.3 113 3,659 Financial Police Department 270 40 65.7 9 nla Social Fund(2001)'' 1,802 54 100 60 3,256 All agencies (2002 ex. SF) Administration 437 123 4 Branches 5,943 276 240 Total 6,380 356 244 12,780 "Estimatedemployeesandcollectionbudget. Totalbudgetis744,857 millionsom. 20. Issues. Although a concerted effort has been made to implement a functional organization within the revenue agencies, it has been frustrated by a lack of specialized skills development andtraining. Efforts have also beenfrustrated by the constant pressure to collect more revenues that tend to be short-sighted (Le., without investing in improvements inrevenue administration). These problems also limit the functionality of the Large Taxpayer Unit,This unit was created in 1998 at the republican level, despite the clearly acknowledged efficiencies of concentrating efforts toward compliance on the nation's largest taxpayers and concentrating on the potential gains from reducing intrusiveness intax administration. 2. Tax Baseand Compliance 21. Base. The tax base-and, even more, tax collection--is highly concentrated in a few taxpayers. A mere 73 out of 20,849 corporations subject to the corporate profits tax accounted for 71.6 percent of total receipts for 2001. Many of these companies are the larger government owned "natural monopolies" still subject to a 30 percent corporate profits tax rate this year. The rate for all other corporations was reduced to 20 percent. The personal income tax base i s much less concentrated; in 2001, only 7 percent of all filers fell in the top tax bracket, with annual incomes of above 50,000 som. However, personal income tax withholding is likely to be highly concentrated. 22. VAT and excise taxes are largely collected at the border (68 and 44 percent of total receipts for 2001, respectively). Only 23 of 118 excise taxpayers contribute 82.1 percent of total domestic excise collections. Even for the VAT, 84 of 8,702 taxpayers account for 48.8 percent. Finally, the land tax, a local tax with minimal ad valorem attributes, is chiefly collected inthe more valuable agricultural areas of the nation (three of the nation's seven oblasts holding the fertile, irrigated, valleys of the country-Chui, Jalal-Abad, and Osh-accounted for about two-thirds of total land tax collections in 2001). 23. Exemptions. There are relatively few significant tax preferences. These are mainly for: specific companies (e.g., the Hyatt Hotel, Kyrgyz Petroleum, and the private cigarette producer, Remsma); for Free Economic Zones (although as a whole the Zones 8 are taxed on goods flowing into the domestic market, making them a typical Export Processing Zone); for agricultural producers; and for communal services. As provided in the Tax Code, agricultural producers pay a land tax in lieu o f all income taxes. Farmers pay Social Fund contributions (which are collected using a the land tax as a proxy), and agricultural produce i s a VAT exempt supply, which means that agricultural producers do pay VAT on their supplies, although it i s ostensibly refundedthrough a fixed credit for processors, recently cut by over 50 percent as a revenue increase measure. Agricultural producers also pay water fees, although well below cost recovery levels, for O&M o f irrigation channels (the key spending o f the government in the sector), which appear as non-tax revenues inthe state budget. Communal services (gas, heat, water, electricity) are also exempt supplies. This means that the companies pay VAT on their inputs but can only pass the tax on to their industrial consumers. Since the prices o f these services are tightly regulated, these companies are being decapitalized by a combination o f taxes on inputs(e.g., VAT) and lowtariffpolicies. 24. While in principle exemptions are not the most pressing issue in tax administration, the enforcement o f key taxes by the agencies appears to be erratic, particularly for SOEs (both loss making and profit making). For example, the state- owned gas company paid profit taxes inthe amount o f som 3.6 million in2000 and 2001. It did so despite heavy cumulative losses of som 90 million (672 million accordingto the audited statements). Another issue i s that the revenue collection agencies, including the Social Fund, do not appear to be making sufficient progress inincreasing the key tax base by expandingthe number o fregistered taxpayers. As Table 1.5 suggests, the total number o f contributors to the Social Fund (the agency that issues tax identification numbers on behalf o f all agencies) has hardly increased over the past three years. Table 1.5: Number of Contributorsto the Social Fund, 1999-2002 2002 1999 2000 2001 proj. in`000s Contributorsto the Social Fund, of which 893.1 898.0 902.0 903.9 Number of enterprises 324.4 326.2 328.2 329.3 Budget (number o f employees) 276.4 273.3 270.3 270 Numberof agriculturalenterprises 55.4 53.9 52.5 5 1.6 Numberof privilegedenterprises 1.0 1.0 1.0 1.0 Number of farmers 218.6 224.1 230 231 Other 17.4 19.5 20 21 25. Compliance. The sole practical means o f increasingthe share o f tax collection in GDP is through improved compliance. This is because tax rates are already close to international norms (except for the recently reduced and relatively low-yielding corporate and personal income taxes, with their maximum 20 percent rate) and few substantial tax exemptions exist whose removal could provide a boost to revenues. A property tax at present under consideration may provide significant revenue for local governments. Its implementationnationwide is, however, several years away. The nation already places a heavy reliance on consumptiontaxes-VAT, retail sales, excise, and turnover-and lacks the capacity to rapidly increase coverage and revenue from direct taxes. A reassessment o f the way inwhich automobiles, particularly luxury models, are taxed may also provide further revenues. This leaves mainly indirect tax enforcement as a principal vehicle for 9 achieving higher tax compliance. This leaves a comprehensive approach-dealing with the supply o f corrupt behavior as well as the demand for evasion-as the only realistic solution. 26. No comprehensive study has measured tax evasion in the Kyrgyz Republic, although it is universally heldto be very high. As canbe seen inTable 1.1, the yield from income, corporate, excise, land, and customs taxes appears low-particularly in an international context. There may also be scope to increase the yield of VAT, 27. Although doubtlessly influenced by the structure of the economy, with a substantial share o f production coming from lightly taxed agriculture, evasion i s widespread. It presents a significant challenge to the nation and to the perceived legitimacy of its institutions. Poor compliance results, not only in financial difficulty in meeting basic government obligations, but it also raises troubling issues concerning the rule o f law. Inthis context, tax evasionmay be a symptom o f deeper problems. 28. Much of the low compliance results from smuggling. Fuel prices in Kazakhstan and Uzbekistan are substantially lower than in the Kyrgyz Republic, and borders are porous. Small-scale smuggling of a few liters of gasoline at a time is a cottage industry readily apparent on any road near the country's borders. Nonetheless, revenues indicate that such smuggling i s much more pervasive on a larger scale. An assessment of smuggling conducted by the Ministry of Finance earlier this year found that at least half of the gas stations inthe south were selling smuggled products. Inaddition, the level of vehicle taxation appears low by international standards; it has eroded over time from US$16 per vehicle a year in 2000 to US$6.5 at present. There are also inequities in the tax for vehicles, since a Lada pays nearly the same rate as a Mercedes T, despite their difference in engine and value. There is, therefore, more room to increase the collection rate from taxes on fuel andvehicles. 3. Tax Arrears and Non-cash Payments 29. Arrears. Reported tax arrears stand at around 0.5 percent of GDP, a relatively low percentage. Still, income tax and land tax arrears increased rapidly between 2000 and 2001 (Table 1.6) and are cause for concern for tax administrators. Social Fundtax arrears are increasing rapidly (nearly tenfold in the last six years) and exceeded 1.5 billion som as of April 1, 2002. These Social Fund arrears dwarf total tax arrears and have a direct impact on the republican budget, which i s scheduledto provide 745 million som in subsidies in 2002.13 They also suggest that there i s a more fundamental problem inthe designofthis tax (Chapter 7). l3Excludingthe employer share for government employees. This is a substantial increase over 2001, due to a reduction in the employer tax rate from 29 to 25 percent enacted in the fall of 2001, and effective for calendaryear 2002 andthereafter. 10 Table 1.6: Arrears by Tax, 1995-2001 (Million Som, End o fYear) 1995 1996 1997 1998 1999* 2000 2001 Individual income tax 24.2 0 6.1 19.3 21.4 20.4 44.6 Corporate profits tax 24.2 39.5 33.8 46.8 36.1 41.2 55.9 VAT" 54.4 87.7 373.8 240.1 190.9 163.5 161.8 Excises 25 11.8 16.8 19.1 15.2 11.2 9.9 Roadtax 4.5 10.4 36.6 16.4 14.4 32.7 23.4 Emergency tax 12.6 23.1 19.9 41.3 31.2 15.4 27.0 Land tax 9.2 14.7 21.3 55.3 44.2 35.2 50.2 Other 6.2 21.7 1.3 15.2 15.0 12.6 19.5 Total tax arrears 160.3 208.9 509.6 453.5 368.4 332.2 392.3 Net change .. 48.6 300.7 -56.1 -85.1 -36.2 60.1 As percent oftax collections 6.6% 7.0% 9.3% 6.2% 4.3% 4.3% As percent of GDP 1.0% 0.9% 1.3% 0.8% 0.5% 0.5% Increase in Social Fund revenue arrears 36.7 81.4 70.1 117.3 137.0 293.0 382.0 Net change As percent of Social Fund collections Assessed penalty and interest Total arrears, penalty and interest, Social Fund 1,49 1 I'IncludesarrearsbuiltupbyKyrgyzgasintheamountof88million,92million,and105millionsomat end-1999, end-2000, andmid-2001,respectively.These arrears are relatedto the fact that VAT is not imposedofficially on residentialconsumers andtherefore the VAT is leviedas an input tax. Giventhat tariffs are controlledat levelslower than cost recovery (includingthrough low norms for non-metered consumers), the company cannotaffordthis inputtax. Sources: STI and Social Fund. Excludes SCI arrears. 30. Although the stock of tax arrears is low, the flow within the year is extremely volatile. This, in turn, indicates serious problems with some of the nation's larger companies, particularly in the energy sector. Thus, for instance, in 2001 arrears in the corporateprofits tax increasedfrom 41 million som at the start of the year to 543 million som four months later, following non-payment of declarations. Gradual payments and mutual settlements over the remainder o f the year reducedthese arrears to 56 million som at the close of the year. This means that the low level of reported arrears i s tightly linked to the use of offsets and mutual settlements. 31. A similar pattem is developing in 2002, with corporate profits tax arrears increasing to 581 million som as of May 1, 2002, out of a total stock o f reported arrears of 822 million som. For taxes other than the corporate profits tax, arrears were 241 million som, a value smaller than that at the end of 2001, meaning that the stock of other taxes has decreased. 32. The problem with the enterprise income tax is linked to the governance of SOEs and joint-venture companies, and to pricing policies for public utilities. Mutual settlements and offsets facilitate continued soft-budget constraints and a low penalty 11 structure (more on this subject i s given below). In the case o f public utilities, whose prices are controlled, arrears reflect the deferral o f a decision to impose a realistic pricing schedule. 33. Non-cash Payments. Over the past few years, the government has made attempts to eliminate mutual settlements whereby tax obligations are settled by bartering goods such as agricultural products, or in which tax offsets are used by the government to pay private and public firms for services. A provision inthe 2002 budget law, adopted inthe fall o f 2001, prohibits such settlements in the republican budget. The provision recommends their elimination by oblast administrations and the municipal authorities o f Bishkek andOsh. However, their use is entrenched andnot easily eliminated.14 34. Payments in kind are also commonplace in social taxes. This i s because agricultural producers are subject to this tax (unlike the VAT and direct taxes) and because Social Fund collection officials facilitate a redistribution process, thereby transferring commodities collected inlieu o f taxes directly to local pension recipients in a non-cash transaction. The latest information from the Social Fund indicates that mutual settlements for 2001 were equal to 213 million som, or 6.5 percent o ftotal revenues. 35. The introduction o f hard budget constraints and the strict elimination of mutual settlements and offsets will most likely lead, inthe short term, to increases in arrears in the enterprise profits tax and possibly a spillover into the VAT. It would then be necessary to realign the prices o f public utilities and to attempt to prevent the emergence of arrears from consumers to public utilities. 4. Selected Issues i. RevenueEstimatesand Quotas 36. The revenue agencies in the Kyrgyz Republic still set targets based on planned, rather than forecast, revenue. The use o f revenue targets as a management tool points to the absence of alternative systems of accountability and control within the revenue agencies. The targeting system i s used extensively and i s set by tax, by collecting agency, and by administrative unit. Although theoretically there could be an economic basis for each assignment, in reality the targets are negotiated amounts based on last year's collections, with few adjustments for intervening economic changes or even changes in tax law. 37. The use o f revenue targets induces severe distortions. To meet the targets, tax officials either request or negotiate advance payments from taxpayers. This practice clearly breaks the concept o f self-assessment central to a modern tax administration. The detailed targets may also induce a misclassificationo f collected tax revenues. Inaddition, the use o f revenue quotas leads to nonpayment or delays o f VAT refunds for regular exporters. Without a fully functional refund system, the VAT effectively results in a substantial tax on exports, rendering goods uncompetitive. The priority given to meeting l4There is a substantial problem in the reporting o f offsets by the tax authorities, reflecting a state o f near denial despite widespread knowledge that utilities pay their taxes through net outs for their services. As a result, official data report only a very small percentage ofmutual settlements (Le., 25 percent oftotal tax collections in2001). 12 the revenue targets has frustrated recent administrative attempts to simplify the tax refund process by replacing a cumbersome process under which a refundhad to be approved by upto seven agencies with a simplifiedprocedure. 38. Under this new procedure, local STI offices may authorize refunds for regular exporters without limitation. However, since the quotas are assigned to the individual offices, a surge in export activity from regular exporters, and consequent refunds, might cause an STI office to fall below its target. Revenue from any compensating imports does not accrue to the STI office, but to the SCI office. Past attempts to segregate funding for refunds have failed. They are likely to continue to fail until the issues of quotas, and the effect o f refunds on quotas, are settled. 39. Other perverse incentives are in place that also make good administration difficult. For example, income and profits tax revenues above the target amount are shared differently from the base amount: local governments retain 75 percent instead o f 35 percent, o f revenues, while local office staff and directors are held accountable for collections relative to these targets. However, incentives in the collection system will continue to put pressure on local governments to underestimate revenues inthese shared taxes. For these reasons, the government has recently made the improvement o f the local revenue estimation capacity a priority. ii. BudgetaryAccountability 40. The way in which revenue agencies are funded limits budgetary accountability and makes administration difficult. The problem i s budgeting "special means funding," or revenuethat is retained by the collecting agency. Major sources o f special means funding for the SCI include: charges for the registration o f goods and transport, costs o f storage, auctions o f unclaimed goods, certification and training o f staff, registration for banking institutions, and revenue from the identification o f contraband. The STI receives revenue from charges for tax registration, and from forms, and revenue from detected hidden income. 41. Special means funding provides incentives for agencies to devote their efforts to collections that benefit their agencies directly, rather than the national budget. For example, sharing the additional revenues coming from the identification o f contraband and from hidden income provides an incentive to misclassify receipts so as to meet special means funding goals. Charges for registration and forms also present an unnecessary obstacle to voluntary compliance. Moreover, special means-funding may limit the accountability o f the agency to the national government through the budget process, as this alternative source o f funds can cushion the agency's budget against policy changes. Furthermore, a confusing battery o f fees and charges for routine matters i s not conducive to developing a service orientation or encouraging compliance. iii. Information Sharing 42. The fragmented nature o f the administrative structure still creates barriers to both information sharing and the consolidation o f administrative functions, despite the significant steps taken to unify tax and customs information inrecent years. These steps have included the development o f a uniform taxpayer identification number for all legal entities in 1997 and a successful project in 1999 that resulted in one number for all 13 citizens for tax and Social Fundpurposes. Inearly 2002, the government announced the implementationo f a "one-stop" registration system, inwhich one numberwould serve for the Social Fund, STI, SCI, National Statistics Committee, andMinistryof Justice. 43. It has not been possible to fully exploit the opportunities provided by these initiatives. For example, it i s impossible to use Social Fund return data to determine compliance with individual income tax payments. Moreover, data collected by customs are available to tax inspectors only nominally, despite agreements between the agencies, owing to technical difficulties. These uniform registration numbers, combined with consolidated accounting and auditing procedures, would greatly facilitate communication. They would allow for more effective and less intrusive compliance measures and improved audit selection techniques. iv. Internal and External Controls 44. Internal control within the revenue system i s weak. The main agency responsible for identifyingtax violations and controlling corruption i s the Financial Police, created by combining the STI `Internal Investigation Department, the STI Tax Police, and the Internal Security Department o f the SCI.'5 The independence o f the Financial Police was intendedto provide it with objectivity and to reduce duplication. However, by becoming an agency external to the agencies it i s charged with monitoring, the Financial Police has lost its linkages to internal data within the agencies, owing to confidentiality requirements and to technical and procedural obstacles. Now, the agency can do little more than monitor the functioning o f the collections agencies from a distance, with no noticeable impact on collections or on a reduction incorruption. Providing access to the data that are needed to thoroughly evaluate agency performance and ensure compliance i s difficult, however, and is, understandably, opposed by the agencies monitored. 45. Within the tax agencies, the development of uniform procedures and internal controls i s limited by the lack o f statutory authority to issue binding regulations or instructions, the result o f a parliamentary reaction to perceived abuses o f rulemaking authority. InJune 1999, Parliament adopted legislation that eliminates the ability o f the Ministry of Finance to issue compulsory instructions, binding on taxpayers and tax officials alike.16 As a consequence, the development o f binding commentary has stalled. Jurisdiction i s uncertain, pending decisions by the Parliament, which has to date undertaken that development itself. The lack of these powers has seriously affected the joint work between taxes and customs. This absence o f meaningful administrative rules requires agencies to refer all legal or administrative ambiguities directly to the Tax Committee o fthe Legislative Assembly, an inefficient and nontransparent process. V. Audit Selection 46. An additional consequence of the quota-driven system o f collections, the low level o f computerization in tax administration, coupled to the inadequate skills level in revenue agencies due in part to low salaries and turnover, i s the failure to implement a Decree o f the Presidentof the Kyrgyz Republic dated 21 January 2001. l6Kyrgyz Republic Law o f July 13, 1999 # 71 enactedfrom July 1, 1999, deletedArticle 8, section3: "The instructions shall determine the procedure o f applying provisions of the Code. They are compulsory for all residents and non-residents, but any provision of the instructions, which contradicts the provisions of the present code is out of legal force." 14 selective method o f audit and enforcement to replace the existing universal audit concept. Because o f the lack of information to guide selection, auditing today i s ineffective. It is largely focused on formal controls rather than on investigation and i s likely to represent an opportunity for corrupt practices. A first step in improving the audit process would be to develop the Large Taxpayer Unit. Over time, the country should set up the basis to move to advanced practices, where taxpayers are selected for audit on the basis of likely audit productivity, a function o f potential evasion, and collection amount. This assessment may be based on the audit o f a comprehensive sample o f returns, with audit results used to calibrate a model that would link return characteristics to likely yield. vi. Appeals 47. A fully functional tax system requires the existence of complementary internal and external appeals mechanisms. The Kyrgyz Republic has an operational internal appeals process. Appeals can, at first, be filed with the appropriate local STI office, which has 30 days to reply or the appeal i s automatically granted. The STI office's decision may be appealed to the Ministry o f Finance or the STI, which typically does not reverse local decisions. According to data received from the STI, in 2001, 581 appeals were filed," o f which 388 were settled in favor o f the government, 113 were settled in favor o f the taxpayer, and the remaining 80 resulted in a compromise. Most filings are inthe City of Bishkek or Chui Oblast; two of the seven oblasts report only one appeal filed inthe past two years. 48. There has been a recent troublesome decline inappeals-from 837 in 1999 to 581 in 2001. Most of this decline occurred in appeals filed inthe City of Bishkek, which dropped from 397 to 245 over this same period. Eventhough taxpayers have a reasonable chance (one chance in three in 2001, even before the appeal to the STI Central Appeals Division), this decline may indicate alternative and perhaps improper solutions to taxpayer problems. 49. All decisions o f the Ministry or STI may be appealed to the courts. This is not commonplace, owing perhaps to the perceived corruption within the legal system and to the lack o f specialized expertise inthe court system. The Tax Conception calls for the creation o f either a tax chamber within the civil court system, or a separate tax court; however, constitutional issues on judicial specialization have to date prevented such action. Appeals can also be filed directly with Parliament, and, in 2001, 121 appeals or inquiries were filed with the Tax Committee of Parliament by individual taxpayers. Inthe first six months o f 2002, 92 letters were received. As obstacles to the judicial appeals system emerge, Parliament may become another avenue for external appeals. However, the capacity and expertise for reviewingsuch appeals are limited. vii. Penalties and Interest 50. At present, the penalty structure does not favor timely compliance and, moreover, sets a low priority on the collection o f penalties and interest. And the determination o f penalties i s fairly complex. Collections of penalties and interest are very low and accounted for about 5 million som, or 0.06 percent o f total tax revenues, in 2001. The j 7This number is notparticularlylow. A much larger country, Ukraine, reportedaround6,000 appeals in 2001, and results are muchmore favorable to taxpayers inUkraine than inthe KyrgyzRepublic. 15 stock o f penalties and interest was approximately 750 million som as o f May 1, 2002, roughly equal to the stock o f arrears at the same date and far above the stock at the end o f 2001. Article 47 o f the Tax Code gives taxpayers the opportunity to assign payments to the principal amount o f delinquent taxes; that, combined with other provisions o f the Tax Code that give penalties and interest a lesser status for collection purposes, results in a structuring o f repayments to cover only the principal. 51. Accordingly, the present set o f rules for penalties and interest on overdue payments provides a soft budget constraint for companies while, at the same time, the lack o f a transparent framework i s a soft budget constraint on the agencies. This could become particularly troublesome if the country effectively eliminates offsets, compensations, and payments inkind. Taxpayers may find it economically advantageous to delay payment, in which case tax arrears might well explode. It i s important to align the structure o f penalty incentives to induce timely compliance with tax obligations. Care, however, should be taken not to make the penalties excessive, since that can often have the opposite effect. D. CONCLUSIONAND FUTURE AGENDA 1. Modernization of the Revenue Collection System 52. The government is, at present, consideringthe consolidation o f revenue collection agencies into a single agency or other related major reorganization. The merging o f the administrative structures would generate benefits in both audit effectiveness and in the ability to use less intrusive compliance measures such as computer-based analyses o f returns that would be facilitated by information sharing. Although such consolidation i s amenable to piecemeal implementation, it i s complex and time-consuming. Consolidation should be implemented carefully and with the overarching consideration of avoiding any disruption inrevenuesystem administrationand the resultant collections problems. 53. The progression o f consolidation under discussion within the government would begin with the collection o f Social Fundpayments by the STI, starting in 2003. Under some variants, it would continue on to the reincorporation o f the Financial Police into the STI and SCI as part o f a new revenue agency and the integration o f support systems. Finally, under one scenario, the current agencies would be replaced by a single revenue agency underthe Ministry o f Finance. 54. A gradual approach to the integrationo f revenue agencies has a greater chance of success, as the experience o f Georgia and Armenia shows. The only two nations with fully integrated revenue systems are Canada and the Netherlands. Other countries have managed, at best, to have a single agency with separate tax and customs units. The gradual approach also seems adequate because the benefits o f integration can be realized at a stage far short o f full consolidation, with further coordination between taxes and customs yielding immediate benefits. 55. Inproceeding even with partial integration, careful consideration should be given to the emerging structure of incentives. For instance, with respect to reassigning Social Fundcollections to the STI, attention should be given to any potential shift inincentives to collect one set o f taxes or another or to account for revenue in other than a budgeted 16 manner. This would require that the revenue authorities see their mandate to collect revenues as being without preference as to who owns the taxes. As a consequence, government leaders would have to ensure that Social Fund revenues and republican revenues are properly allocated, and that any arrears and other deficits are allocated in a deliberate and transparent fashion. Finally, the issue o f mutual settlements and collections in kind would have to be addressed in merging Social Fund and republican budget collection procedures, so that the infrastructure for managing goods that belongs to the Social Fundis left behind. 56. Finally, compensation reform and wage scale decompression should be considered a component o f a comprehensive anticorruption strategy to help retain and to encourage the recruitment of highly skilled staff. If well implemented, civil service reform beginning with the revenue agencies could provide a successful pilot for such reforms elsewhere. Through higher tax compliance and increased investment, it could provide funding for broader-based reforms. Past efforts have focused only on reducing the size o f the bureaucracies and not on improving their functionality. An internal functional review o f the tax and customs systems could be undertaken to consider improvements to internal processes, such as developing risk assessment for audits, enhancing large taxpayer units, and providing a more service-based administration system. 2. InformationSharing 57. An important aspect o f the modernization process will be to deal forcefully with the problems that have emerged with the integration o f support systems such as data processing and auditing. Data processing consolidation will be especially difficult, as systems were independently designed and, in the case o f the STI collection system, KITIS, have not been completely implemented. It is also necessary to create an institutional basis that would enable the different agencies to conduct joint audits and inspections, inwhich the audit by one agency would be accepted by another. Inthe same way, restrictions, either practical or legal, on sharing information between agencies should be reviewed and eliminated wherever possible. Accounting systems should be made consistent among agencies; reporting structures and data management systems could be united under a common format. This i s critical to non-intrusive compliance measures andto minimizing audit productivity. 58. Rather than attempting to share data with an external agency, it may be far more prudent to reintegrate the Financial Police into the SCI and STI. Any efficiency gain from consolidation i s likely to be outweighed by the severing o f the internal auditors from the data they are to audit. Rather than attempting to design systems to provide less limitedaccess, it may be more efficient to reintegrate the 270 employees into the revenue agencies. This reintegration should not necessarily recreate the Tax Police in its former configuration, but should make it part o f a more advanced audit and collection system. Such coercive collection procedures as those under the former system might prove counterproductive to achieving increasedvoluntary compliance. 17 3. Simplificationofthe OrganizationalStructure 59. The geographical distribution o f field offices should be reviewed as well; they should be consolidated where appropriate. Despite the needfor a customs office at each border crossing, 240 branch offices for all collection agencies in a country o f under 5 million people may be excessive. This i s especially true as limitedresources would mean that training and skills development programs, and the upgrading o f physical equipment, could not be implementedin all offices. Such consolidation should be undertaken jointly with the revision of internal procedures and the development o f new information management systems, since it could reduce costs significantly. Such simplification could also help with the eventual devolution o f the collection responsibilities to the regional and local authorities. All in all, there should be clear allocation of responsibilities to the revenue agencies; the current system o f dual subordination, with tax officials answerable to boththe national and local administrations, should be eliminated. 4. RevenueEstimatesand Quotas 60. The government should continue to pursue the basing o f revenue estimates on objective economic forecasts at the sub-national level, rather than following the past indicative-plan-based system o f negotiations. This requires developing the capacity to estimate revenue potential at national and local levels. It requires implementing effective strategies to achieve revenue potential. Moreover, it requires developing internal measures other than targets for evaluating performance and creating adequate incentives to fully implement a system o f self-assessment. Dealing with the perverse incentives that block VAT refunds should be a priority. 5. IntergovernmentalFiscalIssues 61. The government should also review the system o f collection and allocation o f national and local taxes, in the context o f administrative restructuring and also in the context o f fiscal decentralization. Shared taxes could be replaced by surtaxes on national taxes to eliminate the incentive for under-forecasting, and, to some extent, the negotiation component o f revenue estimation. Furthermore, small taxes that are not cost-effective to collect, such as the taxes on flowers, dogs, and local symbolism, could be eliminated, with local governments having greater discretion over rate setting for the remaining taxes. Similarly, the capacity for local self-govemments to administer local taxes locally, instead o f through agencies of the national government, should also be developed, especially in the case o f larger cities. The pending city property tax could be implementedinsucha manner as to provide boththe funding and the incentive to do so. 6. SpecialMeansFundingand BudgetaryAccountability 62. Special means funding should be heavily restricted, if not eliminated, because o f the perverse incentives it provides and the manner in which it limits public accountability. The Budget Code should be modified so as to provide that all public revenues are paid to the Treasury. Performance bonuses for the agencies should be structured insucha way that managers do not face a distorted set o f incentives. 18 7. Arrears and Offsets 63. The country would benefit from moving to a system o f cash payment for taxes and contributions and eliminating mutual offsets, barter, and payments in kind. These practices are symptomatic o f a soft budget constraint; they provide opportunities for corruption, and have resulted in an artificial inflation o f collections. Eliminating these practices would have the perceived effect o f a temporary drop in revenues, as figures become more realistic, and could also pressure an increase intax arrears. 64. Preventing the accumulation o f arrears and reducing the existing stock o f arrears would require a broad arrears enforcement strategy. Inparticular, it would be important to avoid issuing general amnesties that would weaken tax compliance. Such a strategy should provide precise directives for approaching different types o f cases in a fair and transparent manner. The relationship between the pricing o f public utilities and the tax obligations from the utilities should be carefully examined. Adequate provisions should be made for the transition to financially sustainable prices. For privately owned entities and joint ventures, arrears could be broadly categorized according to ability to pay and repayment methods. 8. Penaltiesand Interest 65. A balanced structure o f penalties and interest is required to facilitate compliance and to do away with existing incentives to delay payments. Interest and penalties should assume a collection status equivalent to the delinquent tax itself. Interest must continue to accrue on all delinquent amounts-penalty, interest, and interest itself-and the Tax Code provision that limits interest to the amount of the initial delinquent tax should be eliminated. In addition, the structure o f all penalties should be reviewed, and any discretion givento the tax official should be eliminated. 9. Taxation of SOEs 66. The current system o f taxation o f SOEs, and of pricing structures, and the consequent rise in arrears, may result in a soft budget constraint for the enterprise if output i s priced by the market, or in an implicit subsidy where prices are controlled. In the case o f the former, strengthening payment discipline will result in a conversion to a hard budget constraint. In the case o f the latter, strengthening payment discipline will leadto a system o f taxation based on a reasonably measured ability to pay combined with a pricing schedule that will allow the recovery o f these taxes. It will also increase the transparency o f the fiscal system and help in the transition toward market pricing o f goods. 10. Audits and Compliance 67. The concentration o f the tax base and payment responsibilities ina small number o f taxpayers indicates that substantial gains incompliance and collection efficiency could be achieved through the implementation o f a fully functional Large Taxpayer Unit. This would replace the current department that exists in name only. Additionally, improved methods o f audit selection, replacing the current bias toward universal audits, would increase compliance and would also reduce taxpayer harassment. For the longer term, 19 consideration should be given to developing a more advanced return-based income tax system. The low compliance resulting from smuggling could be addressed through improved audits, through areform of customs administration, and, inthe case of gasoline, through a focus on larger retailvendors, perhaps through the use of a presumptive excise tax system. 11. Revenue Increase Measures 68. Although much of the above reform program would result in revenue increases through increasedcompliance, these revenues would probably not be sufficient, at least in the short term, to meet the nation's goals of increasing revenues andproviding sufficient funding to eliminate turnover taxes and reduce the payroll tax. Such changes would require substantial base expansions, in the form of new taxes such as the tax on immovable property, and in an increase intax bases and entities subject to taxation. To the extent possible, these changes should be geared toward moving the nation's tax system closer to international standards. This could be done by enacting a reverse charge for VAT combined with a zero rating of business service exports, by carefully reviewing preferences adopted through special agreements with the government for humanitarian purposes or to attract investments, by eliminating exemptions such as that for communal services, and by establishing reasonablerates for taxes such as the land tax and the tax on motor vehicles. Taken together, these changes could do muchto move the nation toward these goals. 69. Inconclusion, for any ofthese reforms to succeed, strong support is requiredfrom the highest levels of government inthe Kyrgyz Republic, which must articulate a vision for the new system o f administration. It must set the necessary directions for implementing this vision, ensuring that the implementation is followed through at every level of government. As the administrative capacity at all levels is weak, these skills must also be enhanced. This is a critical reason for making compensation reform an integral part of any administrative reform. The use of dedicated revenues, although problematic, may protect these reforms from the vagaries of the budget process and may provide adequate funding for their full implementation, Finally, a broad-based and inclusive reform process would suggest the establishment o f a steering committee, comprised of internal and external stakeholders, that would oversee and respond to the implementation process. 20 2. REMOVINGCONSTRAINTSTO RESOURCE MANAGEMENT A. INTRODUCTION 70. The Kyrgyz Republic has taken important initial steps toward establishing public expendituremanagement (PEM) institutions.A basic legal framework for budget preparation and execution was established in the mid-1990s. In 1996, the Treasury system became operational, making the Kyrgyz Republic the first CIS country to have a functioning manual Treasury. A revenue sharing arrangement was also designed to provide more stable budgetary financing to the local governments. 71. Currently, the state budget comprises recurrent republican (central) and local government expendituresand the domestic counterpart for foreign-financed projects. The bulk of capital expenditures falls under a separate program--the Public Investment Program (PIP), which still lacks a formal budget formatiodexecution process. In addition, there is an extrabudgetary arrangement for managing social insurance revenues and expenditures--the Social Fund, which is regulated by the Law on State Social Insurance and the Law on State Pensions. The fiscal operations of the Social Fund are reported to Parliament. 72. Efforts notwithstanding, the annual budget does not yet provide a comprehensive picture of the coverage of all thefiscal activities. Key steps have not been taken invarious areas, such as the integration of the recurrent and capital budgets. Various off-budget activities also make it difficult for the authorities to prioritize the use of resources. Moreover, the state budget is fragmented by a widespread use of non-cash transactions and special means. Finally, a number of social activities are run through state-owned enterprises (SOEs) inthe form ofhighly subsidizedprices. 73. This chapter focuses on: (1) extrabudgetary funds and off-budget transactions; and (2) factors that fragment the budget.18 These two sets o f issues are tremendous impedimentsto the ability of the authorities to react to shocks or to change the course of fiscal policy. Certain activities are run as entitlements outside the budget. This is inappropriate given the need for the authorities to adjust fiscal policies. Non-cash transactions, special means, and to some extent protected items in the budget, predetermine budget outcomes to a large extent. As a result, there i s generally a wide difference between the budgets and the actual outcomes in spending by function. This can be seen in Figure 2.1, which combines the state budget with the initial implementation plans regarding the PIP for the year 2000. ~~ ~ The chapter does not give extensive coverage to the full PEM agenda, which the authorities are developing in close collaboration with the World Bank (through a Governance Structural Adjustment Operationandthe FinancialAccountabilityAssessment),the IMF, and other donors. 21 Figure 2.1: Implementationof Spendingin the State Budget and the PIP, by Function,2000 Other Interest Agriculture total SocialSecurity & Welfare Other economc affairs Education total Healthtotal Transport and communic Mining & Manufact Fuel and energy Housing total GPS Defense Public Order Recreation & culture Total expenditure 0 20 40 GO 80 100 120 140 74. Table 2.1 attempts to quantify quasi-fiscal activities discussed in Chapter 4, Volume I,and some o f the expenditure activities (based on the limitedset of information available for some of the activities) for 2001. Quasi-fiscal operations inthe power sector alone accounted for about 7 percent of GDP. This, and at least 14 percent of GDP of public funds handledthrough extrabudgetary funds and off-budget operations, brings the size of the state in 2001 to about 42 percent o f GDP. Out of this total spending, Parliament approves only 18 percent of GDP when it reviews the state budget, and an additional 5.4 percent when it considers the budget of the Social Fund in a separate session. Parliament also receives an attachment on the PIP (4.4 percent of GDP), but does not approve it." Table 2.1(C) also illustrates the degree of flexibility inthe state budget. Of about 18 percent of GDP, about one-third cannot be changed as it is tied as special resources or offsets. Ifprotected items are included, then only 5 percent of GDP can be effectively decided upon. Strong short-term action in these areas is a prerequisite for greater selectivity and prioritization inthe use of budget resources. It i s also essential for reining inthe country's fiscal stance. The analysis in Chapter 4, Volume Iis based on the consolidation of these three items made by IMF and World Bank staff. 22 Table 2.1: Expenditure Allocation by Level of Government and Extrabudgetary Funds, 2001 2001 YOGDP YOintotal Broadly defined total expenditure 41.8 100.0 A. Quasifiscal Operationsand Management of SOEs na na. 1. Price Subsidies a! 7.2 17.2 2. Operational savings (-) or losses of SOEs b/ na na. B. Extrabudgetaryfunds and Off-budget transactions 13.7 32.7 1. ExtrabudgetaryFunds na na i Socialfund, ---- Health O.W. 5.4 13.0 Social InsuranceFund 0.2 0.5 EmploymentFund 0.2 0.5 PensionFund 4.8 11.6 & MedicalInsuranceFund 0.2 0.5 ii.SmallandMediumEnterprisesupportfundc/ 0.01 0.02 iii.Privatizationfundd/ 0.1 0.1 iv. Economic developmentstate fimd na na v. State Material Reserve hnd e/ 1.o 2.4 2. Off-budget Operations 5.0 12.0 i.Grantsoutsidethebudgetf/ 0.6 1.4 ii.ForeignfinancedPublicInvestmentProgram 4.4 10.5 C. State Budget Expendituresg/ 18.5 44.2 1. Spendingthrough special means 1.6 3.8 2, Non-cashsettlement h/ 4.9 11.8 3. Protecteditems i/ 6.9 16.4 a/ Price subsidies and losses (abovenorms) for electricity. Other price subsidieswere not calculated. b/ Not regularlycompiledby the fiscal authoritiesor the State PropertyFund. This is the only partof the fiscal activitiesthat is approved by Parliament, althoughParliamentalso approves the SocialFundbudget inaseparate session. c/ Financedfrom 3 percentshare ofprivatizationproceeds. d/ Financedfrom 7 percentshare of privatizationproceeds. e/ Total resources spent by this fund are classifiedas confidential.Amounts includedare estimatesbasedon the realizationof in-kind assistance. E/ Includesan in-kind grant worth Yen 800 million in2001 as well as about 4,600 tons of diesel fuel purchasedthroughthe proceeds ofthe second Japanese Grant (KR2). g/ Amount approvedby Parliament, excludes SocialFundandthe foreign-financedPIP. h/Includespaymentsofutilities, subsidiesto SOEs, paymentsfor privilegesto SOEs, VAT refundfor gas, halfofUMB, halfof capitalrepairs, andcollections from the EconomicDevelopmentFund.Non-cash settlement could also be estimatedas tax collections from the energy companies, plusthe relatively smaller amounts reportedby the Treasury as collections in-kind andoffsets. i/ Wages, social security contributions,and foreign interest payments. Source:World Bank staffcalculationsbasedon information from the MoF andother agencies. 23 B. EXTRABUDGETARYFUNDS OFF-BUDGET AND TRANSACTIONS 1. ExtrabudgetaryFunds 75. There are 8 extrabudgetaryfunds in the Kyrgyz Republic handling about 15 percent of total public resources, but probably handling more, since accounts are not availablefor many of thesefunds. These funds include the State Social Fund (which i s comprised o f the Pension, Social Insurance, Unemployment, and Medical Insurance Funds), the State Material Reserve Fund, the Privatization Fund, the Small and Medium Enterprise Support Fund, and the Economic Development State Fund. 76. The extrabudgetary funds have been set up to provide revenue stability to the activities considered priority fields for public sector intervention (e.g., micro-enterprise development, or social security), and as an incentive for a selected number o f agencies (i.e., the State Committee for Management o f State Property, or the Economic Development Fund). 77. The revenue stability for a selected number of activities and entities, however, comes at the cost of instabilityfor the rest of the budget. Leaving an independentsource o f revenues (Le., earmarking taxes) reduces the effective tax base available to policymakers for fiscal policy. It also makes it difficult to take stock o f the entire system o f public interventions-a key objective in the formulation o f the Medium-Term Expenditure Framework and the National Strategy for Poverty Reduction. Moreover, the multiplicity o f extrabudgetary funds undermines oversight and accountability in the management o f public resources. Many o f the arrangements (all but those under the Social Fund) are outside o f any formal budget framework; thus, oversight o f the full range o f financial activities undertakenby these funds i s limited, since their activities are not subject to the regular procurement and reporting requirements that apply to budgetary institutions. 78. This PER recommends: (i) the Economic Development State Fund; (ii) closing downsizing the State Material Reserve Fund; (iii) corporatizating or closing the Small and Medium Enterprise Support Fund; and (iv) integrating the Social Insurance Fund (although reduced in scope), the Unemployment Fund, and the State Property Fund into the budget.The Medical Insurance Fundandthe PensionFundare discussed inChapter 5 and 6, respectively. Inview of the country's limitedresources, a sharp break with the use of extrabudgetary funds is very important. O f course, no new extra-budgetary activities shouldbe created, including the road fundthat has beenunder discussionfor some time. i. Employment Fund and Social Insurance Fund 79. Currently, each of these funds receives 1percent of the payroll tax, earmarked for a variety o f activities, including the provision o f unemployment benefits, retraining, and other programs for the unemployed (Employment Fund), the financing of maternity leave, and compensation for work-related injuries (Social Insurance Fund). At present these two funds promise substantially more than they deliver. More important, there i s 24 little rationale for their activities to be run outside o f the state budget, and some o f these activities may not evenbe appropriate to the role o f the government. 80. The strategy should therefore be to assess which o f the activities o f these funds should remain the responsibility o f the republican or local governments, and which should be phased out. Those that are deemed necessary should be carried out as part o f the budget.For example, unemployment insurance or interventionsare bettermanaged as a budget line that can be expanded during periods o f retrenchment (in the public or private sector) or during economic slowdowns, andthat can be reduced at all other times. ii. Small and Medium Enterprise Support Fund (SMESP) 81. The main function o f this Fund, which receives 3 percent of the privatization revenues, i s to provide micro-credits to the enterprises. The SMESP does not appear to maintain proper accounts o f its activities (overall portfolio, re-flows, operating costs, etc.), or, at least, such accounts were not made available to the Bank. It i s therefore difficult to assess the magnitude o f this Fund, as well as its efficiency and sustainability-although clearly it i s a relatively small activity. 82. The funding and administering o f micro-credits by the state, which may have beenimportant at some point, no longer seems appropriate. Over the past two years, one micro-credit institution (i.e., FINCA) was substantially strengthened, and a line of credit inthe PIP was restructured to support microlending (PESP). The authorities are working with the EBRD to initiate further microlending activities. The Kyrgyz Agricultural Corporation i s also active in micro-credits. This i s a clear case in which government support should be phased out, althoughthe SMESP could be corporatized. iii. Privatization Fund 83. The State Committee for Property and Foreign Investments (SCPFI) has been allowed to keep 7 percent o f the privatization revenues every year. It is unclear whether these funds are topped-up with all or part o f the revenues from the leasing o f SOEs- some o f which appear to be inthe general budgetunder non-tax revenues. 84. While the SCPFI's funds are likely to be spent on various legitimate activities, no formal report on utilization i s prepared for Parliament and other stakeholders. More generally, while many o f the SCPFI's activities are well within the realm o f the government's role, there i s littlejustification for runningthem outside the budget. Infact, it is inthe interest o f the Ministryof Finance as well as the SCPFI to show Parliament that the management and privatization o f SOEs involves costs. Greater oversight o f SOEs i s needed, and this oversight must start by increasingthe transparency o f the SCPFI. iv. Economic DevelopmentState Fund (EDF) 85. This Fund is responsible for managing the state's on-lending portfolio (on behalf of the Ministry o f Finance), which includes processing on-lending agreements as well as collecting debt service. It is also responsible for collecting old budgetary loans (even though many o f the beneficiaries o f these loans no longer exist). The Fundearns a fee on 25 the amounts it collects from enterprises or farms, which is larger for bad debts than for recurrent debt service. It i s unclear whether the Fundkeeps accounts on its own eamings and expenditures, or ifit i s regulated or subject to oversight. 86. There is little rationale for maintaining the current structure of portfolio management. After numerous years o f zero budgetary lending, accounts receivable from old loans are mainly irrecoverable. At the same time, the management o f on-lending agreements, currently limitedfor key public services, i s not a demanding task. Therefore, the EDF should be closed and some of its functions should be transferred to the Debt Management Department of the Ministry o f Finance; other functions (such as debt collection or debt recovery) should be transferred to DEBRA or, through a fair and competitive auctioning process, subcontracted or sold to commercial banks. v. StateMaterial Reserve Fund (SMRF) 87. The SMRF is an extrabudgetary fund under the State Commission on Public Procurement. It i s responsible for maintaining about 100,000 tons o f wheat and other food supplies for emergency purposes. For this purpose, it often receives in-kind assistance, procures wheat directly, or receives wheat that i s collected in-kind by the revenue administrations or the EDF.The SMRF's day-to-day functions include storaging and rotating (selling and buying) the stocks in the market. Often, rather than selling stocks, the Fundprovides wheat to the budget, which in tum uses it to pay transfers in- kind (e.g., to poor households) or sends it to certain spending units (military, prisons, etc.). 88. While inprinciple the SMRF reports to the budget(it receives a budget allocation mainly for its personnel), in practice its accounts are not transparent. In fact, weekly transactions, stocks, and financial flows are considered highly confidential. The SMRF retains 10 percent o f revenue from each operation, which i s not reported to the budget. More important, the SMRF i s often used to support enterprises (Le., for quasi-fiscal activities). Recently, a new SOE was created for the purpose o f trading and marketing Kyrgyz products. While the budget provided no funds as capital, the SMIW allocated about 1,500 tons o f wheat flour (approximately KGS 10 million/US$225,000, assuming the average price of flour i s about KGS 7/kg) to this new concem to sell and use as working capital for further operations. 89. .. There are two options for increasingthe transparency and oversight o fthis Fund: To include the full set o f accounts o f the SMRF in the budget-and provide a detailed annex on its implementation for Parliament To corporatize the SMRF and ensure that audit and other procedures o f disclosure are put inplace. 90. Regardless o f the option that i s selected, the level o f the stock should be adjusted downward over time (Le., the size o f this fund should be reduced) and information about its activities should be made public. There i s also a strong conflict of interest in that the 26 SMRF is under the agency that is supposed to supervise, and advise on public procurement,all government agencies-including the SMRF. 2. Off-BudgetTransactions i. Off-budget Grant Financing 91. Not all foreign grants are recorded in the Treasury, which makes it difficult to provide a complete picture of the operations regarding the use o f foreign grant assistance. This i s especially the case with commodity grants, which generate financial flows for the recipient line ministry. 92. Currently, the Treasury includes bud et support grants received from the European Union (Le., Food Security Program$' or from bilateral donors cofinancing adjustment operations (e.g., generally, grants from the Dutch and Swiss governments). However, data on the US. wheat program and on Japanese government grants are not systematically incorporated into the budget, even though these grants finance the state's procurement and on-lending activities, and also provide support to public enterprises (see Box 2.1). 93. Overall, the U.S. government provided over US$168 million during the period 1994-2000 in the form of wheat and other in-kind assistance. Only about US$110.3 million of this amount has been reflected in the Treasury accounts since 1993, of which US$102 million was recordedin 1993 and 1994 andUS$8.3 millionin2000. 94. Another source of grant financing since 1994, estimated at about US$lO million per annum, is the Japanese government's grant assistance. This assistance comprises five different programs and is intendedmainly to support the agricultural sector, but also to support health, education, public transportY2'public and culture. In total, Japanese assistance inthe amount of US$70 million was provided over the period 1993- 2000, of which only about US$3 million was reflected inthe budget. 95. The U.S.wheat proceeds and the Japanese funds have been managed through the SMRF or the EDF, or directly by the spending units. The way inwhich these funds are managedraises questions about the transparency and accountability of resource allocation (Box 2.1). 2oWith the exception o f 1995, when European Union assistance of about US$65 million was not reported inthe Treasury. '*US$2.1 millionwas provided to the Bishkek City authorities for the purchaseof trolleybuses in2001. US$2.6 millionwas provided in 1999for gas meters. 27 Box 2.1: Kyrgyz Republic: Off-budget Grants from the JapaneseGovernment, 2001 ~~~~ ~ ~ Part of the Japanese funds (i.e,, US$5 million) receivedby the Kyrgyzgovernment in2001 was used to purchase 4,600 tons o f diesel fuel from Kazakhstan for spring works. By the time the fuel was delivered, however, the works had been completed and the government decided to sell the fuel, procure cotton from Kyrgyz farmers, and send it to Belarus in exchange for tractors. Fromthe proceeds of the sale o f the diesel, about 800 tons o f cotton were procured and sent to Belarus in exchange for 96 tractors, part of which shipment has not yet been received. The price of the tractors procured under this arrangement was estimatedat UStSl2,OOO. The tractors were supposed to be distributedto the farmers under the loan agreement with the EconomicDevelopmentFundofthe MoF.Interest-freeloanswere denominatedin KGS, at the exchange rate as of the date of the Kyrgyz-JapaneseGrant Agreement. A three-year maturitywas proposedstarting from the Grant Agreement date andtranslating into an actual maturityo ftwo years for the farmerstaking intoaccountthe procurementdelays. There was no demand for the tractors from the farmers' side and the authorities have decidedto transfer the tractors to the state-ownedKyrgyzAiyl Tech Service. Source: PERMissionmeetings. 96. The Ministry of Finance should include these grants in the Treasury. For this purpose, programs for the prompt monetization o f these-grants must be developed, such as auctioning the commodities before they reach the border. Neither the Ministry of Finance nor any other government agency, should provide credit for the purchase o f these commodities. The purchaser must directly arrange credit from the banking sector. Such a strategy may ultimately reduce the face value o f the commodities, but it would certainly increase the cash flow to the Ministry o f Finance, since the bulk of the credits are usually not repaid. ii. ThePublic Investment Program (PIP)23 97. The bulk of capital investment represents a stand-alone exercise that is not integrated in the regular budgetary process. Although considerable progress was made inharmonizing the PIP with the macro framework when the responsibility for managing the PIP was transferred to the Ministry of Finance, little effort has gone beyond this. In particular, the domestic budget, which includes domestically financed investments and counterpart finds, follows a completely separate budget preparation and execution process from the development budget. Also, Parliament receives an Annex on the PIP, butthis is not subject to approval. Instead, the actual budgetfor eachproject i s negotiated between the Ministry of Finance and the line ministries over the entire year of budget execution (as o f mid-2002, some projects had not yet received budgetapproval). 23A backgroundanalysiso f PIP implementationand issuesis includedinAnnex 2. 28 98. While the domestic capital budget and the counterpart funds are implemented through the Treasury, the implementation o f the foreign-financed capital budget remains outside. For prioritization as well as sustainability reasons, the authorities must make strong efforts to integrate these two processes (Box 2.2). Box 2.2: Kazakhstan: Experience with Reporting Foreign FinancedProjects in the Treasury Prior to 1994, all foreign financed project expendituresin Kazakhstanwere included inthe budget, and managedby the Treasuryby 1996. As a prerequisite to facilitating the expenditure management of foreign financed projects by the Treasury, the budget coverage was extended to these projects and they were included in the budget ceilings. The detailed process was then defined for the release of budget allocations in their local currency equivalent and for Treasury control, accounting, and reporting. The annual financial plans and cash flow forecasting were designed to include the monthly forecast of such project expenditures by standard budget classification and the corresponding loan disbursements by the donors. The Treasury warrants and the ministerial subwarrants were designedto include the allocations for authorizing loan- financed project expenditures. As the system in force favored multiple bank accounts, in-country accounts were kept in commercial banks or the central bank; imprests were initially paid by the donor and subsequently topped up based on a Statement of Expenditures (SOE). Such accounts need prior approval from the MOF/Treasury. Offshore payments(bulk paymentsto consultants or suppliers) made from the accounts were held with the donor. These accounts are generally controlled by Project Implementation Units (PIUs) independent of the Treasury branches and transfer of cash to support budget allocations. The specialprocedureswere developedand enforcedfor such expenditures, as these were not financed from cash transferred by the Treasury but by direct disbursements from the loans. Specifically, detailed Treasury procedures were laid down in 1996 for PIUs to report on such expendituresby budget classification and the correspondingloan disbursements on a monthly basis. The reports were made in two parts: Part 1: In-country payments and reimbursementsreceived from donors: Payments made from special accounts by standard budget classification as used in the sub- warrants and cash in-flows from reimbursements received directly from the donor based on SOE. The accounting reports must be supported by reconciled bank statements to guarantee accuracy and completeness. Payments are incorporated in the Treasury accounts by Journal Entry (Debit to budget accounts and Credit to related Cash Control Account). Reimbursements are recorded as borrowing in the Treasury accounts (Debit Cash Control Account and Credit Budget Account for borrowing) and postedto the detailed loan accounts inthe Debt recording and management systemafter verification. Part 2: Off-shore Davments made by the donors on behalf of the government agency: Payments made by donors directly from approved loan accounts held off-shore will have to be reported in this part by full budget classifications, supported by the donor's statements. These are incorporated inthe Treasury accounts by Journal Entry (Debit budget accounts for project and Credit budget accounts for borrowing) and postedalso inthe detailed loan accounts inthe Debt recording and managementsystem after verification. These measures, inter alia, enable the Treasury to include the fiscal data relating to externally funded projects in its routine budget execution reportsandto keep the loan profiles up to date. Since these transactions take place outside the Treasury Single Account (or similar MoF main account in the central bank), the monetary data reported by the central bank will not normally include these flows. However, the fiscal data reported by the Budget Department to the IMFi WB will include these transactions. Suitable adjustmentsare therefore neededwhile reconciling these two sets of data. Source: S. Ramamurthy,Treasury Advisor, Governmentofthe RepublicofKazakhstan. 29 99. The established practice by which the Ministry o f Finance sets budgetsfor the PIP needs to be further refined until it becomes part o f the regular formulation process. This means that project budgetsmustbe discussed and agreed upon by the Ministryo f Finance and line ministries the year before they are executed-as opposed to the current practice in which discussions on budget allocations continue well into the execution year. The budgetsmust be agreed by Parliament as partof the overall budgetprocess. 100. The next step is to execute the PIP program as part o f the overall budget execution report. A key step i s to clarify the warrants24that the budgetcommissionwould provide to line ministries. The role and responsibility o f the Budget Commission in relation to the Goskominvest Commission must be reviewed. It i s likely that the bulk o f the responsibilities presently undertaken under the umbrella o f the Goskominvest Commission could be carried out by the BudgetCommission. 101. Finally, all transactions made by PIU must be recorded in the Treasury. This should be a relatively easy step since the PIU accounts already belong to the Ministryo f Finance. As part of the Treasury modernization program, a system for the strict conciliation o f bank statements should be developed. c. FRAGMENTATIONTHEBUDGET OF 102. Prioritization and strategic resource allocation in the Kyrgyz Republic i s limited to the extent that the budget i s not comprehensive and i s actually quite fragmented. Many components o f the state budget operate independently, although they are part o f the budget. The discussion below analyzes the cases of: (i)special means; (ii)non-cash settlements; and (iii) protected items. 1. Special Means 103. The budget is fragmented to the extent that a large number o f budget financed agencies (e.g., State Tax Department, State Customs Department, Ministry o f Justice, Ministry of Transportation, Ministryof Education, Ministry of Agriculture, etc.) collect and spend own revenues outside o f the official budget framework and Ministry o f Finance control. The flexibility o f levying and retaining own fees i s tolerated by the Ministry o f Finance, since the budget is unable to take full responsibility inmeetingits formal obligations, including the basic obligations such as paying salaries, allowances, and utility fees. While fee collection may be the basis for the work o f institutions that are not likely to be budget institutions over the medium term (e.g., universities, health providers), it i s not an acceptable vehicle for meetingbudgetary obligations. 104. Special means represent about 8 percent o f overall budget revenues and grants and about 6 percent o f total expenditures (Table 2.2). The special means were traditionally important in financing higher education and tertiary health, but they have 24Warrants is the term used to denote the amounts that the budget commissionauthorizes a given PIU to contract in a given period, which can be set for the quarter rather than the one month period that is authorizedfor domestic spending. 30 recently become a considerable source o f financing in other state agencies. The most important consequence o f special means i s that they provide the wrong incentives for the recipient institutions. The State Tax Administration can keep a portion o f the penalties and fees that it imposes on tax delinquents, which may bias its effort to collect actual taxes. Similarly, the State Commission on Public Procurement and Material Reserves levies a fee equivalent to the "savings" permitted by the procurement process (e.g., the difference betweenthe highest and lowest prices). Table 2.2: Revenue and Expenditure from Special Means, 1999-2001 1999 2000 2001 Percent o f GDP Revenues: Payments for services 2.5 1.8 1.9 State fees 0.4 0.3 0.2 Special means 2.1 1.5 1.7 Expenditures: Special resources, o.w.: 1.8 1.4 1.6 State services 0.6 0.4 0.4 Education 0.6 0.6 0.8 Other 0.5 0.4 0.4 105. Special means also have consequences in terms o f equity. The recent increased reliance o f education on special means i s worrisome (about 15 percent o f total expenditure on education i s presently financed through special means), especially taking into consideration the fact that special means are now levied on basic education-with serious consequences for the equity o f the system and its capacity to address poverty (Chapter 6). 106. Inthe reports ongovernment activities, special meansare shownas a separate line item only on the aggregated basis. The detailed information on the activities undertaken through special means (which i s available) i s not adequately integrated, analyzed, and reflected in the reports on government fiscal activities. In addition, the agencies often retain more revenue than i s allowed by the law, especially during periods o f cash rationing imposed by the budget incases o f revenue shortfalls. 107. The government should develop a clear strategy on special means, including who is allowed to impose and keep the fees and for which purposes (e.g., higher education, semi-private infrastructure entities, etc.), and which institutions must transfer the fees fully to the budget.The proposed case-by-case strategy will override the current practice in which every institution must surrender about 30 percent of its special fees to the Treasury. It i s likely that, under this policy, regulatory or autonomous agencies will keep all collections (e.g., State Energy Agency and Telecommunications Agency), as will institutions that will eventually become non-budgetary (educational institutions, research institutes, and hospitals). At the same time, most o f the ministries would need to fully surrender their collections through special fees. Such a reform must be implementedin conjunction with a revision (and harmonization) o f the government's compensation 31 policies, given that the fees currently represent a significant top-up to the base salary fundedfrom the general budget. 2. Non-cashSettlements 108. Theflexibility of the budget is further limited by a considerable amount of expenditurefinanced by a complex system of cross-subsidies and non-cash operations. Tax offsets accounted for over 20 percent o f total tax collections before 2000, when the official offsets were legally limitedto a maximum o f 4-5 percent o f total tax revenue. The prohibition o f the offsets in itself, without attempts to address the root causes o f the problem, could be regarded only as a short-term solution. To cope with the imposed hard budget constraint, but unable at the same time to consolidate more cash resources, the authorities have worked out a new mechanism-a so-called cash-to-cash transaction. This operationhas several marked differences from the ordinary net-outs or offsets: (i)i s not it documented; (ii) it requires actual cash advances; and (iii)it involves banks as the intermediary agents for the transaction. According to rough estimates, about 20 percent o f the state budget operations are conducted using the cash-to-cash transaction as a means for payment settlements. 109. In addition to impeding competition, the excessive use of such transactions distorts the efficient inter-sectoral prioritization and input-mix balance within the sectors and sub-sectors. Inthe majority o f government functions, spendingon wages and utilities crowds out expenditure on operations and maintenance as well as other spending (a detailed analysis o f the negative effect o f non-cash operations i s provided during the functional analysis o f expenditure). The expenditure allocation is not made on the basis of strategic prioritization but i s biased toward the goods and services delivered by large public enterprises (mainly utility companies) or firms willing to provide the government with goods and inthe exchange of tax offsets and/or other types o fnon-cash settlements. 110. These mutual settlements (or cash-to-cash operations), where the combined current and/or overdue tax obligations (i.e., principal, penalty, and fine) are netted out against certain expenditure commitments, are made on a multi-party basis. An example o f such transactions could be found in any function o f the government. Usually, these transactions are conducted between the budget and the power companies. Because o f cash shortages, the budget i s usually unable to pay for the utilities used by budgetary entities, to honor the direct subsidies allocated to the state enterprises, and/or to compensate the power companies for the cost o f providing free services to the privileged population. The power companies, in turn, owe a substantial amount o f money to the budget (inthe form o f overdue tax payments or on-lent credits). Inthe netting operation, the government cancels its tax or credit claim on the energy company, which counts this as accounts paid for the provided goods and services or direct subsidies. In the process, the tax regime on the one hand and the tariff policy on the other are often blurred to ensure that accounts payable and receivable match exactly. 111. An extreme form o f non-cash settlement (i.e., barter) is still a common practice in the Kyrgyz Republic and is widely used in the transportation, farming, food- 32 processing, and energy industries. Barter suppresses competition and allows inefficient producers to remain operational. A typical example o f barter operation i s the compensation o f social benefits with goods (flour, wheat, or even horses provided to war veterans) and the compensation o f road maintenance with fuel and flour. 112. The problem o f budget flexibility is far more complex than the technical issue related to the form o f payment clearance. It should be addressed comprehensively through reassessing and clarifying the role and responsibility o f the public sector vis-a-vis the private sector andaccelerating structural changes instate enterprises. 113. Clearly, addressing the issue o f non-cash settlements will destabilize the current (mainly paper) budget. While a detailed analysis should be made, what i s more likely to occur in the power sector i s that tax collections will fall and spending increase when taxes are paid following strictly the principle o f self-assessment, and expenditures are reined in by meter reading and on-time compensation for privileges. There is also the need to find financing to break the vicious circle in which the government does not pay utilities for lack o f cash, and the utilities do not pay taxes incash for the same reason. 3. Protected Items 114. The current budget formulation and execution process gives the utmost priority to four protected items, namely, wages, social security contributions, food purchases, and foreign interest payments. While this granting o f priority has been an important instrument in avoiding the buildingup of arrears, it does perpetuate a budget allocation that focuses only on these priority items. In other words, this system does not force the authorities to make choices as to what the role o f the government should be, to the extent that it does not force a reduction in activities, but only in some o f the inputs for these activities (namely, those other than wages and food). 115. As part of the preparation of a full PEM strategy (including Treasury modernization), the authorities should consider a reduced role for such a system. For example, if progress is made toward budgeting on the basis of commitments, the "protected nature" o f the foreign debt i s automatically taken into account during the budgetformulation process. D. CONCLUSIONAND FUTURE AGENDA 116. If the authorities are to improve their resource allocation, the budget must become: (1) more comprehensive, to include off-budget and quasi-fiscal activities; and (2) muchless fragmented. 33 3. STREAMLININGSTATE EMPLOYMENTAND IMPROVINGCOMPENSATION POLICIES A. INTRODUCTION 117. An effective public administration should deliver good quality services, should provide an appropriate regulatory function, and, in the case o f ministries, should participate in the development o f sound sectoral policies. In the Kyrgyz Republic, the consensus is that the administration i s not presentlyable to fulfill these responsibilities to a satisfactory degree. The government's own repeated calls for improved administrative performance and its quest for effective reform strategies recognize this fact, as do opinion surveys that reveal widespread discontent with, and distrust of, public institutions on the part o f citizens and enterprises.2s Many public officials themselves express frustration with a working environment that largely emphasizes rote tasks over substance and does not provide the fulfilling, appropriately paid careers that they seek. 118. This chapter examines issues related to the government's workforce, starting with overviews o f the status o f government employment and pay and analyses o f key systemic issues. Effective government operation goes far beyond questions o f employment numbers and salary levels, however. The latter section o f the chapter highlights issues o f management and administrative culture that have been the subject o f detailed analyses elsewhere.26Although they are difficult to tackle, questions o f institutional and individual incentives are integral to achieving good administrative performance and must be explicitly considered in the design o f any reform proposals if they are to bring about meaningful change. Since the civil service is the administrative elite o f a country, it should be the backbone o f an effective public administration. Therefore, the chapter pays particular attentionto that small, yet crucial, sub-group o f the government workforce. B. EMPLOYMENT REMUNERATION AND 1. Statusof GovernmentEmployment 119. This section provides a quantitative overview of government employment in the Kyrgyz Republic, setting the stage for more detailed analysis in the rest o f the chapter. While all data are from official government sources, owing to collection problems 2s See Governance and Service Delivery in the Kyrgyz Republic, World Bank, 2002, which presents the findings of surveys of citizens, enterprises, and government employees. For example, o f 27 services coveredinthe surveys, only 8 were rated satisfactory by 50 percentor more o fhouseholdrespondents,and 7 by enterprises. At the bottom of the list for both enterprises and householdswere police services, with only 18 percentofrespondentssatisfied. 26For example, in Civil Service Reform in the Kyrgyz Republic, UNDP, 1999, and papersby the European Union's TACIS program. 34 (including missing data and inconsistencies among sources), they should be interpreted with caution. 120. According to official data, total budget-financed civilian government empl~yment~~-includingthe republic level and local governments-was 308,597 in 2001. O f this number, approximately 24,000 to 25,000 are estimated to be civil servants (covered by the current civil service law). Owing to data shortcomings, however, the exact numbers and locations o f civil servants throughout the administration are unclear. Table 3.1 shows the distribution o f budget-financedcivilian government employees by financing source, branch of government, and sector. Since a number o f entities finance staff through so-called special resources (the proceeds o f user fees or other undertakings) there are most likely additional individuals who, although working within the government structure, are technically not financed from the budget and thus are excluded from this figure. Table 3.1: Budget-fundedCivilian Government Employees, 2001 White Blue collar Total Percent collar (ir. service) Republican budget President's & Prime Minister's 1,048 1,168 2,216 2.9% administrations, affiliated bodies (Supreme Authority) Legislative branch 407 51 458 0.6% Judicial branch 2,065 723 2,788 3.6% Executive branch 46,482 20,148 66,630 86.9% O f which Justice & related 391 79 470 0.6% Foreign Affairs 237 43 280 0.4% Environment & Emergency 5,027 971 5,998 7.8% Finance, Tax, Customs 4,514 1,159 5,673 7.4% Education & Culture 5,449 13,816 19,265 25.1% Health 10,852 2,071 12,923 16.8% Labor & Social Protection 5,590 1,019 6,609 8.6% Agriculture 8,753 521 9,274 12.1% Industry & Trade 205 205 0.3% Transport 341 341 0.4% Various committees, agencies 5,123 469 5,592 7.3% Other 4,471 676 5,147 6.7% Total,Republican budget 53,452 23,266 76,726 100.0% Local budgets Public service delivery 7,O 13 1,658 8,671 3.7% Science 245 50 295 0.1% Education 94,048 45,722 139,771 60.3% Culture 5,597 1,111 6,708 2.9% Health 62,439 11,508 73,947 3 1.9% Social protection 2,196 129 2,325 1.O% Agriculture 157 10 166 0.1% Total,Local budgets 271,693 60,287 231.881 200.0% Total budget-financed 225,144 83,453 308,597 *'Thisexcludes employment in the Ministries o f Interior and Defense and in security services, for which data are not available. 35 121. At about 6.3 percent of the population, this falls within a broad range for a number of other transitional and OECD countries (see Figure 3.1). Of course, such broad-brush comparisons give little indication-except at the extreme margins-of the appropriateness of the employment level and, more important, of the government's ability to deliver on its responsibilities. As noted earlier, the Kyrgyz Republic does poorly on a more meaningful measure of the latter, which i s the degree to which the public, government leaders, andemployees themselves are satisfied. 122. The bulk of civilian staff (231,881 or 75.1 percent) is employed by local governments, largelyinthe education and health sectors, which account for 92 percent of local government employment (see Figure 3.2 andFigure 3.3). Figure 3.1: GeneralCivilian Government Employment as Percent of Population 18% 16% 14% 12% 10% 8% 6% 4% 2% Sources: Country data are from the World Bank's updateddatabase for "AnInternational StatisticalSurveyofGovernmentEmploymentand Wages" (World BankPolicyResearch WorkingPaper 1806, 1997,by S. Schiavo-Campo,G. de Tommasoand A. Mukherjee). Datafor the Kyrgyz Republic are from official government sources. 36 Figure 3.2: Employmentby the RepublicandLocal Governments, 2001 250,000 200,000 150,000 100,000 50,000 Republic Local Gov't White collar Jr. service Figure 3.3: Local GovernmentEmploymentby Sector, 2001 I 150.000 I 139.771 120,000 90,000 60,000 30,000 123. At the republic level, most employees work for the executive branch, which had 66,630 staff in 2001. O f this number, only 1,108 (of which 166 are blue-collar "junior service" staff) or less than 2 percent worked in the ministry headquarters offices themselves (Figure 3.4).28Indeed, after several rounds of "restructuring" over the years, staffing of headquarters i s so low as to raise concerns regarding the ministries' ability to fulfill what should be (and is not yet) a key function: formulating and coordinating sectoral policy. Inpractice, Kyrgyz ministries are overwhelmed by rote tasks and by the fulfilling of numerous commands from above; they are also likely to lack the professional skills for such an agenda at present. One of the few clear conclusions that emerges from 28All data exclude the Ministries of Defenseand Interior, whose employment levels are confidential. The vast majorityofexecutive branchemployeesworked indeconcentratedoffices (at sub-nationallevels) or in subsidiary entities, as well as in state committees, commissions, and agencies and their deconcentrated or subsidiaryunits. In2001, civil service employment inministryheadquarterswas: Foreigntrade, 93; health, 45; education, 75; agriculture, 75; transport, 69; labor, 51; environment and emergency, 58; and finance, 275. Datafor other ministrieswere not available. 37 this brief quantitative overview is that, in future, meaningful administrative reforms should address the need for appropriate roles and suitably skilled staff (and staffing levels) inministries. Figure 3.4: MinistryEmployment,2001 10,000 8,000 6,000 "on-headqtrs 4,000 2,000 0 124. The problem is not limitedto ministries, however. Indeed, there is a general need to attain a more appropriate skill composition o f the workforce. As in other transitional countries, the Kyrgyz Republic has staffing imbalances not only inthe area o f skills but also according to geographic area or setting. So, for example, the health sector may face an overall excess supply o f nursing skills, but a shortage inremote areas and in Bishkek, where nurses seek better paying jobs outside o f their profession. Achieving an appropriate skill mix will take time and turnover rather than mere enforcement o f a particular aggregate employment level. 125. The size o f the civil service i s estimated at around 24,000 to 25,000, although, as noted above, data on the number and distribution o f civil servants are inadequate. Estimates based on available data show that about 4 percent o f civil servants work in ministryheadquarters, 4 percent inthe deconcentrated offices o fministries, 66 percent in the headquarters o f subsidiary entities o f ministries, and 26 percent inthe deconcentrated offices o f such subsidiary entities. Since the size and distribution o f the civil service has direct implications for the nature and cost o f reforms (particularly salary reforms), it would be advisable to establish a detailed accounting o f the number and distribution o f civil servants (by entity, geographic location, and position), to make accurate analysis possible. 2. Wage Systems for GovernmentEmployees 126. The Kyrgyz Republic has several separate wage systems for various groups o f employees including the civil service, the social sectors, the central bank, and uniformed personnel. Annex 3 lists the various types o f employees and the principal regulations that govern their wages. In practice, a large number o f regulations (and their amendments) govern each wage system, posing a challenge not only to those charged with implementing current legislation but also, at the republic level, to anyone who seeks to 38 oversee the implementation o f regulations, to develop policy options, or to analyze their fiscal impacts. In fact, for reasons that include difficulties with information flow and constraints on technical skills and staff capacity, little systematic in-depthanalysis o f this nature appears to have been made to date.29 As described later in this chapter, the Ministry o f Finance in spring 2002 launched a laudable effort to collect detailed entity- level data that have the potential to substantially increase analytical capabilities. 127. Inthe social sectors,jobs are slottedinto a 23-leveltariffnet (theUnifiedScale of Rates) that calculates monthly base salaries by applying a series o f coefficients to a cornerstone amount.30 On April 1, 2002, the cornerstone was raised from 120 to 140 som, yielding a month17 salary ranging from 196 som (US$4) at the bottom, to 1,120 som (US$23) at the top.3 An individual's total earnings, however, take into account additional factors such as workload and particular tasks performed. For example, teachers are paid according to the number o f hours taught relative to norms, and receive payments for such tasks as marking student assignment books. Work norms apply to blue collar as well as professionaljobs and insome cases have not been updated since the Soviet era. In the course of interviews, more than one official pointed out that mechanistic norms (e.g., mandating one cleaner per 400 square meters o f office space, or one electrician for a particular number o f electrical outlets) effectively result in a system that pays far less than a living wage while restricting worker output, rather than allowing managers to hire a smaller number o fproductive staff at more acceptable salaries. 128. Inthe case of professional staff such as medical doctors, the restrictive nature of the tariff net and lack o f managerial authority over, and accountability for, budget expenditures have grave implications for service delivery. Skilled doctors, unable to live on salaries on the order o f 1,000 som (US$21) per month leave the profession, take on additional employment, or resort to unofficial payments to supplement their income.32 The health sector is currently implementing a noteworthy pilot project that includes giving hospitals in selected regions greater autonomy inmanaging their budgets as well as in setting salary scales and employment levels. Salaries o f medical staff have risen to as much as 3,000 som (US$62) per month, a level that, while still modest, represents a significant improvement. This undertaking i s likely to yield important lessons for future reforms inthe social sectors and beyond. *' Many records are still kept on paper, rather than in electronic form. To date, central oversight of employment levels has largely been limitedto compilingan annual record (in paper form) that lists a total employment figure for eachentity without greater detail. 30 Coefficientsrange from 1.4to 8.0. 3 1As an example, a newly graduated teacher might earn 500 som (US$lO). Nationwide, the average monthly salary for doctors was 985 som (US$20), o f which 780 som was budget-financed and the remainder came from insurance payments. Mid-level medical personnel earned 705 som (US$15), of which562 som was budget-financed. The exchange rate usedthroughoutthis chapter is US$1= 48.4 som. 32 Unofficialpayments are rampant inthe healthsector, as inother activities in which citizens or enterprises come into contact with the government. According to Governance and Service Delivery in the Kyrgyz Republic, 39 percent of householdsreportedmaking unofficial paymentswhen visitingthe hospital. Fifty- six percentofhouseholdshadmade suchpaymentsto elementary schoolstaff. 39 129. Compounding the low earnings levels, wage arrears can also be a problem- reportedly more so at the local govenunent level, for example, inthe case o f teachers. In recent surveys, nearly halfo f public officials had receivedtheir salary late at least once in the preceding 12months, withpayments delayed by a mediano f30 days.33 i. Structure of CivilServiceEarnings 130. The civil service is paid according to its own wage scale, established by presidential decree and last updated in Decree 196 o f August 1, 2000.34In addition to a base salary, civil servants are eligible for a wide array of allowances and bonuses that account for a significant proportion-generally 50 to 70 percent-of an employee's total earnings. Payment o f certain allowances i s mandatory, while others may be reduced in amount, depending on the entity's wage bill a l l ~ c a t i o nJob-related non-monetary (in- . ~ ~ kind) benefits do not appear to be a significant issue, at least for regular, non-uniformed staff. 131. The system o f allowances and bonuses raises numerous concerns. The sheer number o f bonuses and allowances (at least 11)36and the fact that each has its own criteria make administering the wage system burdensome (at the level of individual institutions, subsidiary entities, and offices). It also makes it difficult (at the republic level) to monitor implementation and ensure that funds are allocated as intended.37 Furthermore, the effectiveness and targeting o f these payments i s unclear. Several allowances appear to serve similar purposes and, while the criteria for certain allowances (most notably, seniority) are clear, others involve a significant degree o f discretion. Such discretion can easily be abused, particularly in a country like the Kyrgyz Republic in which managerial accountability i s weak. Similarly, with few real incentives to focus staff on qualit performance, and little inthe way o f meaningful measures of actual staff performance,3r allowances that ostensibly reward good performance may not actually achieve that objective. A new initiative that i s intended to mitigate inadequate salary levels by awarding increases to particularly valuable staff, while well intentioned, will add to the existing weaknesses, since it will take the form of a new allowance (the "class rank"). 33Governance andService Delivery in the Kyrgyz Republic. 34The Decreedetails 25 sub-scales for employeesthroughoutthe civil service, as currently defined. 35For example, payment o f the seniority allowance is mandatory, whereas the quarterly bonus (which is generally considered to be an entitlement rather than a real bonus tied to individualperformance) can be reducedor suspended as a fhction ofavailable funds. 36 Category, seniority, qualifications, rank, complexity, academic credentials, hazardous working conditions, highaltitude, vacation, material assistance (twice yearly), and quarterly bonus. Certaingroups such as militaryandpoliceemployeesalso receiveadditionalbenefits, for example, reducedutility bills, 37Indeed, the Ministry of Finance discovered in spring 2002, in the course of collectingdetailed pay and employment data, that certain entities had been following obsolete regulations. The cause in this case is unclear, but the large number of regulations (and amendments) issued in the Kyrgyz Republic, and the difficulty in disseminatingthis informationeffectively, compoundthe complexityof the wage system. 38 For example, the new system of attestation asks about employee characteristics and attitudes, but contains no evaluationo f specific work performed, nor does it set substantive, performance-relatedtargets for forthcomingwork. Similarly, one official notedthat his unit is evaluatedprincipallyonwhether it meets deadlinesand onthe number of papers it processes; neither ofthese measures assesses the actual quality of work done. 40 132. As Figure 3.5 illustrates, even in much more developed public administrations with a stronger performance orientation (and, in theory, a greater ability to evaluate performance) it i s unusual for allowances to comprise a large proportion o f total earnings. Inthe mediumterm, it would be advisable for the Kyrgyz Republicto consolidate most allowances into base pay, in order to build a more transparent system in which base salary accounts for a majority o f a worker's earnings. This i s likely to be a multi-year undertaking that should be carefull planned and supported with sufficient analysis o f the impacts o f such structural reform.367 Figure3.5: Base Salary as Percentof Total Earnings 60 40 20 0 Sources: Kyrgyz Republic estimate is based on data compiled by the Ministry of Finance, Source for other data is Trends in Public Sector Pay in OECD Countries, OECD, 1995. Where the source gives ranges, the chart uses the midpoint. 133. While the civil service wage scale is significantly higher than the tariff net used by the social sectors, civil service pay levels remain modest at best, and are considered inadequate by most observers. Based on 2001 data and estimates for nine o f 12 ministrie~,~'one o f the lowest civil service posts (specialist, category 1) in a ministry headquarters earns about 1,960 som (US$40) per month, including all allowances and bonuses, while a deputy minister earns about 9,105 som (US$188) in total. Table 3.2 gives an indication o f salaries-as well as the importance o f allowances-for selected positions inministries. Owing to data issues, these figures may somewhat underestimate actual earnings.41 39For example, one consideration is to avoid reducing a worker's earnings in connection with such consolidation. 40The datawere compiledbythe Ministry of Financeand includeall ministriesexceptDefenseand Interior (whose data are confidential) and ForeignAffairs. 41 Because of data uncertainties regarding two important payments the twice-yearlymaterial assistance - and the quarterly bonus- the calculations assume that each payment amounts to one base salary (in total, six base salaries per year). Particularlyin the case of the quarterly bonus, actual payments may be higher, though they may also be reducedor suspendedsubjectto the size o fthe wage bill allocation. 41 Table 3.2: Monthly Earnings for Selected Ministry Posts Base salary Est.actual total earnings Som $US Som $US Deputy minister 4,500 $93 9,105 $188 Head o f office 3,800 $79 6,378 $132 Head o f chief dept. 3,600 $74 6,498 $134 Head o f division 3,100 $64 6,018 $124 Sector chief 1,800 $37 3,740 $77 Chief specialist 1,350 $28 3,139 $65 Specialist, category 1 1,000 $21 1,960 $40 Specialist 900 $19 Not available Sources: Base salaries from the official civil service salary scale. Estimated total earnings from 2001 data compiled by the Ministryo f Finance. 134. The civil service salary scale is infact a set o f 25 sub-scales for different entities and levels o f government, with prominent republic-level institutions tendingto pay more, and headquarters offices paying more than deconcentrated offices or territorial bodies. 135. Given the underdeveloped nature o f the private sector, publidprivate salary comparisons are difficult to make and are o f limited practical relevance, Salary surveys are unavailable and, for all but a few staff with niche skills (lawyers or financial specialists with Western expertise) or special opportunities, moving to a comparable post outside the administration (without leaving one's profession for commercial undertakings) i s not a real option. Indeed, numerous civil servants expressed an eagerness to leave for higher paying jobs while at the same time lamenting the lack o f such opportunities. While some individuals in Bishkek may find employment in connection with donor projects, the majority o f rank and file staff have few options but to try to make ends meet by minimizing expenditures. Inli ht o fthe fact that the minimum monthly "consumption basket" is 1,316 som (US$28), 4F this can mean going as far as relying on garden plots and in-kind assistance from relatives in order to reduce expenditures on food. 136. An additional feature o f the pay system (less important than earnings levels but worth noting nevertheless) i s that the salary scale i s somewhat c~mpressed.~~ High- ranking ministry staff at the top o f their careers earn perhaps four to five times more than the mostjunior civil service position. This means that the official salary provides only a moderate incentive for an individual to take on the greater responsibilities and the added workload that i s presumably associated with more senior posts. Incontrast, in developed economies where the public sector must compete with private opportunities for top skills, compression ratios between7 and 10 are not uncommon.44Thus, decompressing earnings 42Average for 2001. 43In addition to the base salary scale, some managers report redistributing "extra" wage bill fbnds (from vacancies or other under-spends) in a manner that gives preference to lower level staff, who are particularly hard hit by low salaries. 44For example, compression ratios are 9.8 in the United Kingdom, 8.9 in the United States, and 8.2 in the Netherlands (Readyfor Europe: Public Administration Reform and European Union Accession in Central and Eastern Europe, World Bank, 2000). Compression ratios serve as a rough and easily available 42 i s clearly a lesser priority than addressing either the low pay levels or the structural problem o f allowances and bonuses. ii. WageBill Issues 137. In 2001, government expenditures on wages and salaries amounted to an estimated 5.8 percent o f GDP.45As with employment numbers, owing to the high level o f aggregation of such data, to concerns regarding data accuracy (particularly for countries with under-developed information systems), and to legitimate variations in country needs and contexts, cross-country comparisons o f wage expenditures are o f limiteduse except at the extremes.By this limitedmeasure, the Kyrgyz Republic's wage bill is not excessive; it even falls at the low end o f the ranges. Judged by more meaningful criteria such as the sustainability and effectiveness-in terms o f administrative performance-of wage expenditures, however, there i s little reason for complacency. A further reason to pay close attention to practices related to the wage bill i s that, since budget flows inthe Kyrgyz Republic often take the form o f in-kindtransfers rather than monetary transactions, the wage bill i s in fact one o f the larger monetary flows. 138. Under the present system, any cost savings resulting from employment cuts are retumed to the general budget, with none kept by the body that bears the cuts. As o f spring 2002, a pilot initiative was under way to officially allow the saving institution-in this case the Ministry of Education--to retain a portion of funds thus saved for its own use. Such measures could help institutions focus on attaining a rational employment structure. They could mitigate somewhat the damage to morale caused by staff reductions. It must be noted, however, that retrenchments do not immediately translate into savings, owing to severance and unemployment costs. Furthermore, any savings that do eventually arise may not necessarily be sufficient to finance a noticeable rise in salaries for the remaining staff. iii. Oversightof Employment and WageBill Expenditures 139. In the absence of computerized payroll and personnel systems, the Kyrgyz Republic does not have a robust system for monitoring whether wage bill funds are well spent. The monitoring o f employment expenditures relies on paper submissions (such as detailed accounting forms for individual salary payments) and rote compliance checks o f paperwork as it i s passed up through the system. These reports are highly aggregated by the time ministries submit them to the Ministry o f Finance and the Treasury to request indicator of earnings potential, though they are not as insightful as other, more data-intensive methodologies. 45 The actual cost of the government workforce is higher, since some entities use self-generated revenues ("special resources") to finance additional posts or to supplement budget-funded salaries. An analysis of the 2001 budget execution report shows that 414 million som (0.6 percent of GDP) of the total amount of special resources was used for salaries and contributions to the Social Fund. This means that about 10 percent of total salaries is financed from special resources. The extent of reliance on these funds varies significantly among functions, with little or no salary-related use o f such funds in defense, public order, social protectiodsocial insurance, and mining. In contrast, such financing amounts to 39 percent of total salaries inthe transport and communications sector, 19percent inhousing, and 16 percent ineducation. 43 transfers o f their wage bill allocation. It i s difficult to see how such a system could safeguard against intentional misappropriation of funds or simple errors (such as the recently discovered cases o f organizations using obsolete wage guidelines). While audits by the Chamber of Accounts might theoretically uncover some problems after the fact, that body presently lacks sufficient qualified staff to adequately scrutinize personnel expenditures. 140. Untilnow, central records of employment levels have consisted primarily of an annual paper-based report that compiles total employment figures submitted by each organization. Employing organizations and their subsidiary units do hold more disaggregated data, although such data are not always in readily accessible electronic form. However, such data had not been systematically compiled until the Ministry o f Finance's spring 2002 initiative to create an electronic database detailing employment andexpenditures down to the level o findividual posts and allowances. This initiative is a good interim solution to the current dearth of data. It deserves to be continued, with expanded coverage and updates at appropriate intervals. Given the limited capacities that the Ministryo fFinance can devote to the project, as well as the fact that organizations are already burdened with overly frequent reporting requirements, an appropriate interval would probably be every 12 (or at most, 6) months. 141. However, such a database does not replace the need for multi-purpose management information systems that track actual (not simply reported) expenditures and contain built-in safeguards to ensure that payments are legitimate. Given the administration's heavy reliance on paper records, the introduction o f electronic systems will entail significant design andplanning work, as well as a considerable investment in hardware and training. iv. Designing of Pay and Employment Reforms 142. Inspring2002the MinistryofFinance began compiling position-by-position civil service data for individual entities as part o f a collaborative effort with the World Bank to improve fiscal impact analyses o f pay and employmentpolicies. These data were usedto construct a pilot model that automatically calculates the costs that a given set o f changes in civil service pay and employment levels (down to specific positions) would incur in wages, employer contributions, severance payments, and unemployment insurance over a series o f years. The model allows users to set key parameters and to decide the speed and extent o f reforms; it i s designedfor easy use, with minimal software skills needed. While the pilot model i s restricted to central ministries, with adequate data it could easily be expanded to the rest o f the civil service.46 Annex 4 contains a number o f sample reform scenarios, developed with the model as a means o f highlighting some o f the issues and trade-offs that such reforms will involve. 143. To illustrate the scale o f impacts that various types o f reforms may involve, these scenarios are summarized in Table 3.3. These scenarios are not intended as specific 46The model is available from the Ministry o f Finance's State Sector Department, and the World Bank (ECSPE). 44 policy proposals. Rather, the purpose i s to explore the differing impacts that various policy measures cause, thereby highlighting some o f the issues that must be addressed in order to develop good policy proposals. Table 3.3: Summary of Sample Model Scenariosfor Civil Service Assumptions 24,000 civil service staffat start o f reforms Pay and employment structure of the entire civil service is the same as that for the headquarters offices Newly unemployed workers receive severance benefits of 3 months pay at average salary of 3,700 som, and monthlyunemploymentbenefit of625 som for 12months No inflation, anda stable exchange rateofUS$1=48.4 som Reformsimplementedover 5 years and all changestake effect onthe first day o f eachyear Policies simulated Fiscalimpact at end of reform period Annualwage increases of I137.1% increase in annual uersonnel costs. Wage bill increases to $29.1 5-1 1%; higher rankedstaff million, employer contribubons to $7.3 millioi. Over five years, $28.2 get larger % increases.No million inadditional costs (relative to maintainingthe baseline). employment reductions Status quo maintained Annual wage bill of $21.2 million, plus employer contributions of $5.3 million Annualwage increases as 25.6 % increase in annual personnel costs. In year 5, wage bill is $26.7 above.Employmentin million, employer contributions$6.7 million, unemploymentand severance Senior andJunior grades costs $0.9 million. Over 5 years, $26.0million in additional costs (relative cut 10 percentat start of to maintainingthe baseline).Employmentfalls to 21,716. year 5 Annual wage increases as As above, 25.6 percent increase in annual personnelcosts. In year 5, wage above,Employment in bill is $26.7 million, employer contributions $6.7 million, unemployment Senior and Junior grades and severance costs $0.9 million. Employment falls to 21,716. However, cut 10percent to any over 5 years, additional costs (relative to maintaining the baseline) are wage increases being $13.1million, comparedto $26.0millionabove. 144. The type o f fiscal impact analysis demonstrated here should be part o f any reform proposal. So, too, should consideration o f qualitative issues including equity (for example, should all posts receive the same increase?), the possibility of targeting key skills that are in short supply, the social impact o f any employment reductions, and the question o f whether such reductions would damage the delivery o f core services or functions. 145. Neither computer models nor the type of quantitative overviews presented inthis chapter can provide easy answers as to the specific measures that should be implemented. It is widely agreed that many public servants find it difficult to support themselves on their official salaries. At the same time, dramatically raising salaries across the system is not an affordable option, nor would it necessarily be a wise one, since the effectiveness o f the current employment structure is questionable. Furthermore, such measures in isolation would certainly not solve entrenched problems with poor performance or the systemic emphasis on rote tasks and mechanistic compliance that detract from substantive activities and hobble administrative performance. In developing its reform program, the Kyrgyz Republic will need to determine what i s appropriate for its own circumstances, taking into consideration substance as well as sequencing (see Box 3.1). 45 146. In recent years the Kyrgyz Republic has implemented a series of employment reductions and has revisedthe number o f government entities inexistence. In2001, a 10 percent reduction in administrative employment was mandated, followed in 2002 by a reduction of some 5 percent. Owing to insufficient data, the degree to which these reductions affected "live" employees as opposed to simply eliminating vacant posts i s unclear. Furthermore, some o f the reductions were accomplished with relative ease as members o f certain nationalities chose to emigrate and some professionals found employment abroad. It is quite likely that if further reductions are necessary in the future, they will become increasingly difficult to carry out as (with vacancies largely eliminated) they would affect actual wage earners, with resultingsocial implications. 147. Iffurther employment changes are to have a meaningfulimpact, they should be grounded in substance and should be consistent with a comprehensive strategy for the structure and functions o fthe public sector. One method would be for changes to be made inconjunction with sectoral reforms, rather than beingdriven bynumericaltargets. With thoughtful analysis and commitment, such approaches can work. A promising example i s evident in the Kyrgyz health sector, where a proposal to retrain nurses to operate local drugstores has the potential to alleviate both the oversupply o f nurses and the difficulties with the availability o f pharmaceuticals inoutlying areas, while minimizing social costs. A second way could be to identify, across the administration, functions that could be eliminated or reduced-again, tied to a comprehensive strategy-as a means o f achieving intelligent, rather than mechanistic, reductions. 148. The Kyrgyz economy is not presently capable o f absorbing large numbers ofjob seekers. If any substantial employment changes are to take place (including in overall employment levels as well as in turnover in the types o f staff, as organizations seek out new skills to suit their changing roles), it is imperativeto develop proactive strategies for providing real assistance to any displaced workers. This goes far beyond relying on a few piecemeal retraining programs. It means developing a robust strategy that not only identifies a variety o f mechanisms for helping workers make the transition to viable new jobs (including, for example, providing start-up capital or micro-credits for small businesses) but that also designs sound means o f delivering such assistance so that it reaches those who need it, whether they are in cities or in remote areas. Since such undertakings are not without cost either in terms o f effort or money, any strategy must also include realistic cost calculations and must identify financing sources. 3. InstitutionalCulture 149. In-depthanalyses by donors such as the UNDP and TACIS, as well as the World Bank's own assessments, have identified a variety o f systemic problems facing government workers.47 A brief characterization of the prevailing culture could hardly fail to point out difficulties such as: 47See, for example, Civil Service Reform in the Kyrgyz Republic. 46 Persistent politicization, with a weak distinction or no distinction between political appointments as opposed to apolitical career posts, and little real protection from political interventionindaily operations An excessively centralized, rigid management system that keeps executive branch entities busy churning out rote reports on orders from above and responding to numerous inspections, but allows little room for substantive work, analysis, and strategic thinking A combination of little real managerial autonomy (over budgets and work programs) and little accountability for performance. 150. There is no doubt that these and other problems are the legacy o f the Soviet era and that such dynamics are extremely difficult to change. The Kyrgyz Republic has made laudable efforts to spur better functioning o f the government and its workers; these efforts include the passage o f the civil service law in 1999 (see Box 3.1) as well as a stream o f decrees and resolutions intended to push reform. However, it must also be stressed that real change needs careful design as well as persistent support for implementation. Ongoing efforts to create a robust civil service framework and to ensure organizationalperformance illustrate this point well. Box 3.1: Sequencingof Civil Service Pay and EmploymentReforms: The Albanian Case ~ At the start of its transition, Albania first reduced the size of its public sector through privatization, leaving the country (population approximately 3 million) with about 155,000 public sector workers. From 1997 to 2001, this number shrank to about 115,000 employees, largely because of reductions in vacant posts as opposed to "live" staff. During this period, wages stagnated in nominal terms and declined slightly in real terms due to inflation. In 1999, with donor support, Albania passed a revised civil service law that significantly improved upon an earlier law passed in the early stages o f the transition. Inadditionto spelling out merit-basedrecruitment andmanagementprocesses, the law defined the civil servicewage structure. Among other things, it specifiedthe componentso f earningsand, inmost cases, their maximum weight. However, the law also left some limited room for discretion- a situation that allowed the Council of Ministers (the Cabinet) in 2002 to consider awardingadditional payment for certain hard-to-recruitskills, suchas information technology. In the 2002 budget year, Albania instituted a new salary scale for the civil service, practicallydoubling salaries. Provisions were also made to improve salaries in the health and education sectors. After this increase, civil service salaries were judged to be broadly competitive with comparablejobs outside the public sector. This has eased the difficulty o f recruiting new staff with skills appropriate to the administration's needs, althoughthe introduction oftransparent, merit-basedprocedureshas increasedthe time andeffort neededto carry out recruitment. The massive increase in civil service salaries was fiscally possible because the civil service is a tiny proportionofpublicsector employment-approximately 2,000 out ofatotal of about 115,000. However, the increasehas fueled wage demands by other groups o f employees. InAlbania, the civil service salary scale is formally linked to other categories of employees, such as judges; that scale, in turn, is tied to others. In addition, even without formal linkages, the rise in civil service salaries prompted demands from other groups. While each country must find its own path, the Albanian example illustrates the importance of consideringnot only the sequencingand scale of civil service reforms, but also how such measuresfit in the context o f overall governmentemployment. Furthermore, as Albania recognized, civil servicereform necessitates putting into place appropriate formal institutional rules (a robust civil service law and supportinglegislation) andpayingattentionto the informalnorms that governworkplace activities. 47 151. The 1999 civil service law and related regulations include provisions governing recruitment, promotion, and attestation (a form o f personnel evaluation). At the ministry level, officials are familiar with the law and refer to specific provisions as guiding their actions.48 This is, initself, a positive feature. Inmany respects, the formal provisions are not unreasonable. They include a requirement for the advertising o fjob openings, and the formation o f committees for hiring and promotions decisions. At the same time, there i s room for improvement. For example, while the attestation process collects feedback from multiple evaluators as well as the employee, it focuses on characteristics and attitudes, rather than emphasizing actual performance inspecific tasks. 152. Itis impossible to determine the extentto which actual practices truly embody the principles o f merit, objectivity, and competition. Countries like the Kyrgyz Republic have decades-long experience with command-and-control management; they have an ingrained understanding o fthe importance o f following the letter, ifnot necessarily the spirit, o f the law. Anecdotal evidence includes reports o f job applicants being asked to withdraw in favor o f a preferred candidate, and o f money or favors being given to obtain jobs. While such practices can occur anywhere, inmore developed countries they are often restrained by robust oversight mechanisms and by the fact that managers are held accountable for the performance o ftheir unit(which motivates them to hire competent staff). That neither o f these practices i s in evidence in the Kyrgyz Republic suggests that, until the real incentives governing the workplace beginto change, performance and integrity problems will remain a significant drain on the public administration. 153. Indeed, existing attempts at ensuring compliance-in the narrowest sense o f the term-are themselves a problem. The numerous and frequent inspections provide an opportunity for rent-seeking, in addition to demanding significant resources in the form o f the inspectors themselves and inthe time that they require o f units being inspected. In one ministry, the director o f the financial department estimated that the department undergoes about two inspections per month and added, only half injest, that as soon as one inspection i s finished, another one starts. The point here i s not to argue that there should be no oversight. Rather, oversight should be substantive rather than rote, and should be part o f a system that gives managers autonomy to do their jobs well, in conjunction with appropriate incentives and rewards. Clearly, such a system i s not created overnight, but it i s important to bear the principle inmind when devisingreform measures. In addition, the Kyrgyz Republic can draw on the positive experiences o f existing pilot projects (such as the health sector's hospital management initiative) as well as other pilots infuture. 48This observation is supported by surveys, which found that 72 percent of officials reported being fairly familiar with the Law (Governance andsewice Delivery in the Kyrgyz Republic). 48 c. CONCLUSIONAND FUTURE AGENDA 154. Reforming the system o f government employment, and the environment inwhich government employees work, will require a sustained effort. Among the important projects that must be tackled (many o f which are outside the scope o f this chapter but have beenanalyzed elsewhere) are the following: Changing the informal practices that govern everyday working life, and the actions o f rank-and-file staff and managers and, in turn, o f organizational units. At issue i s the extent to which individuals have real behavioral incentives to focus on doing their jobs well. For example, are they held accountable for the substantive quality and impact o f their work - or only for the quantity o f reports and the number o f deadlines met? Designing and implementing a transparent, fair salary system that is fiscally sustainable and manageable. Over time, this will certainly necessitate consolidating allowances into base salary, and reducing the excessive discretion that pervades the current system. Given the lack o f detailed data to date, an important practical step should be the continuation and expansion o f the Ministry o f Finance's data collection effort. Data on their own, however, are o f little use; the government should cultivate permanent staff with the technical expertise needed to develop sound wage policies. At minimum, such staff should be able to fully use analytical tools such as the fiscal impacts model presented in Annex 4 to conduct rigorous fiscal analyses o f policy proposals. As Annex 4 explains inmore detail, issues that mustbe dealt with include: a Socialwelfare andequityconcerns inthe salaries awardedtovariousposts 3 The financing o f wage increases and associated severance and unemployment costs 3 The impact o f civil service wage reforms on pay relativities with other groups o f employees, who may inturndemand wage increases 3 The effort to ensure that policy i s implemented as designed-particularly given the opaque and discretionary system o f allowances and bonuses currently inplace The sequencing o f any wage increases and employment reductions a The means oftargeting reductionspredominantly on objective grounds while minimizing subjective or arbitrary action 3 The possible unintendedconsequences o f wage reforms, as they change the incentives facing individuals and organizations. Facilitating employment adjustments in line with sectoral or substantive systemic reforms. Sector managers shouldhave appropriate authority and incentives to ensure that staff numbers and skills are appropriate for actual needs, and should be held accountable for using that authority effectively. The government should seriously explore the possibilities o f expanding successful elements o f pilot projects currently taking place incertain sectors. 49 0 Providing proactive strategies and programs to support displaced workers. Particularly in an economy such as the Kyrgyz Republic's, where employment generation i s difficult and even employed workers are under financial pressure, developing proactive policies to help displaced workers make the transition to other livelihoods i s essential. This should certainly include supporting sector-specific initiatives as well as developing a crosscutting program o f options for those who leave government employment because o f restructuring. The complexity o f this task should not be underestimated. Real time, efforts, and resources will need to be allocated and care taken to ensure that the resultingproposals are viable and produce results. This undertaking should draw on technical expertise and the experience o f other countries (for example, Colombia) that have faced similar challenges. 0 Developing personnel management practices (and information systems) consistent with the above 155. None o f the undertakings in this brief agenda i s particularly simple; the intended outcomes cannot be achieved simply by mandating them. Overall management o f these reforms i s in itself a challenge, one that will be best served by a politically impartial entity that has boththe technical expertise and the authority to see the agenda through to success. The Kyrgyz Republic does not presently have a unit o f suitable stature and staffing-a shortcoming that should be addressedwith care and expedience. 50 4. ORGANIZATIONAL REFORMS A. INTRODUCTION 156. Inthe Kyrgyz Republic, as inall other former Soviet Union (FSU) countries, the state inherited a wide range o f functions. While the state's role has shrunk since then, its span o f activities continues to be too large relative to its resources and capacity. The roles and responsibilities o f government at the central, oblast, rayon, and local level are not entirely clear. Even after some functions have been devolved to lower levels o f government, corresponding organizational units at the higher levels continue to exist and intervene. 157. Inother cases, although functions have been decentralized, adequate amounts of resources are not transferred to the appropriate level, which leads to unfounded mandates. At the central government level there is duplication and overlapping offunctions between the President's Administration and the Office of the Prime Minister, between different ministries, and between different units, departments, and agencies under individual ministries. Realizing synergies and efficiency gains through the merger of some functions-such as tax administration, the tax police, and the collection o f social security contributions-is a real possibility 158. The number of inspection, certification, and licensing agencies continues to be excessive, leading to what are perceived as repeated, rent-seeking intrusions into legitimate business activity. At the regional level, there i s the superimposition o f a Presidentialadministrative network over regular government organizations. The regional governors report to the President's Administration and not to the government, while ministrieshave their own oblast organs. Consequently, at the sub-national level there is ambiguity about the authority o f the governors and the ministries over subordinate organizational units and their accountability for administration and service delivery. 159. Major challenges to economic development are often found in weak public institutions, such as those institutions which develop and outline the ways inwhich public functions are performed. When state intervention i s excessive, when rules and regulations are opaque, and when government procedures are carried out with unpredictability, then private sector investment and economic growth are slowed. A healthy and growing private sector i s shaped not only by the market in which it operates but also by the regulatory, administrative, and institutional environment established by the government. 160. In some cases, the Kyrgyz Republic has demonstrated arbitrariness and unpredictability in policymaking; it has demonstrated bureaucratic inefficiency, and the use o f outdated regulations, which may have impeded innovation and created a barrier to trade and investment. Under such a system, officials are largely unrestrained in the regulations they elect to impose. They operate with relative impunityintheir enforcement 51 actions. In this environment, private parties experience difficulties in knowing how to comply with their official obligations and have strong motivations to either operate unofficially to avoid government regulators or to come to private agreements with individual officials concerning compliance. Such a system may act as an incubator o f corruption and may also impede economic growth. 161. The purpose o f state institutions (and government in general) i s to serve and protect its citizens. State institutions provide services such as education, health care, security (inthe police and military), welfare, andjudicial services. These institutions are required to fulfill their obligations to the citizenry by following rules and regulations, and by adhering to oversight arrangements and accountable practices. When such mechanisms break down and when government institutions fail to fulfill their obligations, public trust i s eroded and government integrity i s weakened. 162. Outlined below are two examples o f weak institutional structures in the Kyrgyz Republic-the Sanitary Epidemiological Service (SES) andKyrgyzstandard. The general point made by these examples i s that public administration reform should consist not only o f a well-grounded regulatory framework (civil service law, rules for compensation, etc.) but especially o f institution-by-institution reform. Indeed, the entire process is a long- term endeavor, in which many developing countries are still struggling to find the appropriate balances. B. SERVICE DELIVERYIN SELECTEDINSTITUTIONS 1. T h e Sanitary EpidemiologicalServices (SES) 163. The first of the two examples, the SES, is the organ responsible for health protection inthe Kyrgyz Republic withinthe structure o fthe Ministryo f Health. Its main functions can be summarized in three groups: epidemiology, sanitary hygiene, and laboratory services.49 164. The SES i s an asset to the country and i s integral to maintaining a certain standard o f health protection. However, the institution suffers from many weaknesses which affect the quality o f its services. For example, there are serious funding issues in the SES, whose services are funded from two sources. Three-quarters o f the total funding comes from the public budgets on the national and local levels. One-quarter i s collected as fees for services to enterprises and organizations. The funding from the public budgets, however, i s marginal; in 1999, for example, 5-7 percent o f the public spending o f the health sector was allocated to the SES. A disproportionately high amount (over 80 percent) goes to staff salaries and other employment costs." This leaves very little 49 The epidemiology function is generally the detection, registration, and reporting of selected human infections, and the sanitary hygiene function covers communal/municipal hygiene, food hygiene, occupational hygiene, and school hygiene. 50 Below the republic level, the allocation o f budgetary resources to SES services is driven largely by the allocation o f staff. The allocation o f personnel to SES at all levels is derived from a formula based on the size o f the population in each territory (oblast, rayon, city). The formula was developed in 1969 and does not incorporate the needs or risk factors specific to certain populations or geographic levels (see Review of 52 money for running operations, utilities, transport, and consumables. Collection o f fees, therefore, i s an essential way for many SES units to keep their operations going. Moreover, there i s no mechanism in place to monitor fee collection and the services performed for fees. As with many o f the government regulatory institutions, the SES i s funded at a very low level relative to the perceived needs for the services that are to be deli~ered.~' 165. The incentive for providing fee-paid services i s quite large, as the institution aims to generate money. The main objective o f collecting fees, however, may supersede the primary goal o f the function o f the SES: protecting public health. This concern with resource mobilization may also encroach on the responsibilities and functions o f other agencies, particularly Kyrgyzstandard, the State Inspectorate on Standards and Metrology (discussed in the next section). As these two agencies are not fully funded by the republican budget (in fact, Kyrgyzstandard i s funded mainly by the collection o f fines), each agency has expandedits activities into the responsibilities o f the other. For example, Kyrgyzstandard tests for biological indices and certifies the safety o f certain products, and the SES conducts many tests relatedto product quality rather than safety. 166. It is clear that the functions o f the SES need to be prioritized and that the organization should be downsized, bringing down its costs and focusing its activities on areas which are fundamental to the health of the The present system, however, penalizes the budget of managers who attempt to downsize and prioritize. Allocations are based on the existing physical infrastructure and historical expenditure patterns; therefore, managers are reprimanded in financial terms when they reduce fixed costs and establishreal priorities for service delivery. 167. Since the SES i s clearly an institution that i s fundamental to the health system o f the Kyrgyz Republic, it should play an important role in public health, especially in health protection. The health status indicators for the people o f the Kyrgyz Republic, however, are quite low by international comparisons, and during the 1990s the health o f the population deteriorated in many important areas.53 The functions of the SES have deterioratedto the extent that their mandate, to protect the health o f the population, i s not being fulfilled.54 Thus, the institution is not only not fulfilling its mandate, but it is the Sanitary Epidemiological Services (SES) in the Republic of Kyrgyzstan, World Bank, WHO Regional Office for Europe,the USAID-fundedAbt Associates ZdravPlus Program, DFID, 2001). 5 1Data are from Review of the Sanitary EpidemiologicalServices (SES). 52 One exampleof a non-priority area with which SES has been involved is the school system; SES controls many features o f arrangements inside the classroom, such as ergonomics, arrangement of curricula, and generalschoolwork. 53 See Review of the Sanitary Epidemiological Services (SES). 54 Itis, of course, damagingto the population and the protection of health standards ifthere are possibilities to buy out of meeting safety standards (such as payment of bribes to SES inspectoratesto "look the other way" on violations, or to prevent future SES inspections). In a survey conducted of enterprises in the Kyrgyz Republic in 2001, 29 percent o f firms that had been subject to a sanitary and epidemiological -inspectionsaidthey had encounteredbribery (see Governanceand ServiceDelivery in the Kyrgyz Republic Results of Diagnostic Surveys, World Bank, 2002). 53 encouraging the unacceptablepractice of allowing the private sector to buy its way out of its obligations. 2. Kyrgyzstandard 168. The second institutional example is Kyrgyzstandard, the State Inspectorate on Standards and Metrology. Kyrgyzstandard's intended role is to serve as the national measurement institute. Among its other functions, Kyrgyzstandard should serve as the nation's leading scientific research and technical authority in the areas of metrology, standards, testing, and accreditation; it should serve as the national laboratory accreditation body, and should adopt intemationally acceptablevoluntary standards inthe interest of the national economy. Laws governing conformity assessment such as standards and laboratory accreditation must be voluntary and must be market driven by industry. 169. In practice, however, Kyrgyzstandard's role is that of a regulatory and enforcement agency which is outside the functions of a national measurement institute and whose focus is primarily on the collection of fines. The agency concentrates on developing regulations for issuing licenses, permits, and certifications, all mandatory and all seen as a means of generating income for the agency (none of these functions is normally associated with the functions of a national metrology and standards organization). The regulatory acts and processes which Kyrgyzstandard generates negatively affect the private sector, which must absorb the addedcosts as well as the time spent inits dealings withthis agency.55 170. The functions of Kyrgyzstandard, as it aims to be both a regulatory and an enforcement agency, result ina clear conflict of interest. Kyrgyz law, however, mandates that Kyrgyzstandard should be both a regulatory and a national standards body.56 The current practices of Kyrgyzstandard's regulatory/compliance regime are unsustainable financially; the resources required to maintain such a regime are tremendous. Utilizing the existing resources will require restructuring Kyrgyzstandard's mandate and relieving it of its regulatory and enforcement responsibilities, to bring it into compliance with intemational standardization practices. 171. To supplement Kyrgyzstandard's resources, the regulation on "Fund of Development and Material Bonuses" gives incentives to staffto issue fines rather than to work with the private sector to achieve compliance. Research conducted by the Pragma Corporation has illustrated that the regulation allows Kyrgyzstandard to levy fines for noncompliance and that the funds collected may be transferred to Kyrgyzstandard's account to be dispensed at the discretion of the Director of Kyrgyzstandard for the following purposes: ''SeeRecommendationsfor Concept within the Reorganization of Central Bodies of State Administration, USAID, March2001. 56A body which is both a regulator and a national standards body is inviolation of the principles set forth in ISOAEC Guide 2, the internationally accepted document that defines the responsibilities of a national standards body. See A Review of Documentary Standards and the Standardization Infrastructure in the Republics of Kazakhstan and Kyrgyzstan, PragmaCorporation Trade and Investment Project, March 2002. 54 purchase and repair o f cars, computers, construction.. .purchase o f buildings, furniture, stationary and other overhead expenses; bonuses and material assistance to employees ofKyrgyzstandard; travel expenses o f Kyrgyzstandard on official purposes inpublic transport within the city; improving working and living conditions; reimbursement o f business trip expenses; material assistanceupon retirement; personal bonuses to Kyrgyzstandard employees; compensation for food cost; organization andholding socialkultural and sporting events; and representation expenses, meetings with foreign delegation^.^^ With such incentives to issue fines (such as bonuses and purchase o f cars), it is likely that Kyrgyzstandard will not easily give up its role as a regulatory and enforcement body. Nevertheless, Kyrgyzstandardmust divest itself o f such functions and must transfer them to the appropriate ministries.The government must prioritize the agency's functions by issuing a single law on conformity assessment, separating voluntary from regulatory requirements, avoiding over-regulating certain areas (such as tourism), and mandating voluntary laboratory accreditation. Such changes are necessary to protect the population from public sector abuse due to over-ambitious regulatory power. c. TRANSPARENCYACCOUNTABILITY AND 173. A number of first steps can be taken to restore institutional integrity within these agencies. Many of the functions o f the agencies profiled are not within the realm of standard acceptable practice. Eliminating unnecessary mandates, streamlining functions and prioritizing and listing mandates are some of the necessary requirements for a more efficient agency. Budgetary resources must also be addressed. Significant funding from the republican budget must be allowed, to eliminate the need to supplement agency resources with fines. At the same time, however, many o f the areas o f activities which these agencies inspect must be either reduced or eliminated ~ o m p l e t e l y . ~ ~ 174. Collecting and disseminating performance assessment data for administrative and regulatory practices can also highlightproblems and can bring about improved and more transparent ~ervice.~'Open governmental practices require that the government provide information on governmental activities, so that the public can check the performance o f those who serve them. Building up a public framework by improving the capacity, integrity, oversight, and credibility o fthe civil service is crucial. Moreover, providing for a process by which citizens may appeal decisions, and in general encouraging the 57A Review of Documentary Standardsand theStandardizationInfrastructure. 58 I t is recognized that many functions o f these agencies are necessary, and, in fact, required, functions. The aim of over-regulation and the abuse o f public sector authority by these agencies is what must be eliminated. 59 In Latvia, for example, regulatory bodies include performance indicators that they use to measure their performance in their annual reports. These reports are posted on the Internet. 55 participation o f citizens in improving administrative systems, would bolster the credibility o f the government, and would restore trust ingovernmental institutions. 175. With regard to the SES and Kyrgyzstandard, in addition to reducing the public sector workforce and streamlining the functions o f the two agencies, the government must initiate a crackdown on unethical behavior among regulators and must provide a transparent and reliable system for citizens to appeal decisions. To sum up, the government must ensure that administrative agencies meet the needs o f the people they serve, that their administrative processes are open and transparent, that administrative decisions may be appealed, and that agency functions are relevant to the market inwhich they operate. Without such standards, it would be difficult to indicate that the institutions are serving the people effectively. D. CONCLUSIONAND FUTURE AGENDA 176. The cases o f the SES and Kyrgyzstandard are examples o f two agencies with a weak institutional foundation, and the effects of this on the people o f the Kyrgyz Republic. The elements o f strengthening public sector institutional capacity, however, require a broad range o f reforms, including: (i) streamliningthe structure (andincreasing the efficiency and transparency) o f the public sector; (ii) removing duplicative functions betweenpublic sector organizations; (iii) strengthening the transparency and the reporting o f the ministries and bodies subordinated, supervised, and managed by ministries; (iv) improving incentives for the recruitment and retention o f staff; and (v) developing performance-oriented budgets inline ministries. 177. The government o f the Kyrgyz Republic recognizes the need for a comprehensive reform o f the public administration. The objective i s to create a professional and flexible public administration that responds to the emerging needs o f the country. The elements specific to the needs o fthe Kyrgyz Republic include the following: Liquidatingparallelism and duplication of functions inpublic sector organizations Transfering part of the authority and functions o f ministries and departments to local bodies o f state administration and local bodies o f governance-city councils and ail okmotus Eliminating some local offices o f republican bodies Reformingadministrative andterritorial divisions inthe country Buildingcapacity at the local government level Increasing the transparency o f the government by establishing andbroadening feedback mechanisms betweenthe state and the public Introducing public control over the activities o fpublic administration and local self- governance Involving the civil society inthe process o f decision-making. 178. The quality o f governance will be a key determinant o f the success o f the Kyrgyz Republic incoping with many o f its challenges, includingpoverty, external debt, exports, and trade. The public sector would need to deliver results on multiple fronts. These fronts 56 would include crafting policies that reduce poverty, stimulate growth, and create a stable macroeconomic environment; implementingpolicies, programs, and projects efficiently; providing optimal utilization o f financial and human resources; providing cost-effective delivery of public services o f adequate quality; facilitating private sector development; maintaining law, order, and national security; and providing capable management o f regional and international relations. 179. To accomplish the above, it would be necessary to develop an institutional framework that places a premium on serving the public interest; demands and provides incentives for performance; ensures value for public money spent; emphasizes accountability, transparency, efficiency, and integrity; and encourages the participation o f the civil society and the citizens inpublic affairs. At the same time, the state must have the appropriate organizational structures and business processes, intellectual and technical skills, and adequate financial and physical resources to perform its assigned functions properly. The Kyrgyz Republic has made notable progress in initiating the modernization o f the state; however, it still has a long way to go to achieve its goal. This process i s a lengthy and complex endeavor, which requires commitment, tenacity, and patience, as the example from Latvia shown inBox 4.1 indicates. Box 4.1: Reforming Public Sector Institutions: The Latvian Example The motivation for reforming Latvian state and regulatory institutions came directly from the government once it had become clear that inefficient practices and bureaucratic procedures had been hindering the state's growth in private sector development, as well as impeding effective public sector service delivery. The Secretariat for Special Assignment of Public Administration Reform took the lead in the areas of government transparency and accountability, administrative efficiency, and human resource management. This involved multiple ministries, state agencies, and others inthe process of changing the already well- established state and public functions. For example, to streamline the regulatory process, the Ministry of Justice completed a manual for drafting laws and regulations based on good legislative techniques. The Ministry of Finance prepared a method for assessing the budgetary consequences of draft laws and regulations; it created a uniform definition and procedure of "normative acts," ensuringthat all these acts are adequatelyreviewed by the Ministry of Justice prior to adoption by the Cabinet of Ministers. To make this an effective mechanism,the School ofPublic Administration developedatraining program for staff on how to undertake impact analysis. The Secretariat and the Chancellery of the Cabinet of Ministers coordinated the efforts of these institutions. At the same time, it involved NGOs, donor institutions, and civil society to provide input into the process. The above example demonstrates the necessityof good coordination efforts throughout government to the progress of particular public sector reform. The leadership of the Secretariat and the Chancellery were especially crucial in bringing key government and non-governmental players into the process. The government soon learned that those who will be affected by the reforms must also be involved in the reform process. This key insight made establishing and implementing new government procedures, while still not easy, a more tolerable and much smoother undertaking. 57 5. HEALTH A. INTRODUCTION 180. The main objectives o f the health chapter inthis PER are to describe and analyze the current configuration o f healthexpendituresinthe Kyrgyz Republic inthe context of health sector reforms; to highlight the effect o f the health reforms on equity, efficiency, and transparency inthe management o f public resources for health care; and, on the basis o f this analysis, to recommend appropriate interventions to improve the performance and sustainability o f the health system. The chapter begins with a description o f the health status. It then discusses strengths and weaknesses o f the inheritedhealth care system, the government's reforms in health financing and delivery, and patterns and trends inhealth expenditures. The chapter concludes with a set o f recommendations for improvingthe efficiency and effectiveness o f health services, based on the analysis in the preceding sections. B. HEALTH STATUS 181. As in most other FSU countries, health indicators in the Kyrgyz Republic deteriorated early inthe 1990s and began to improve inthe middle o f the decade (Table 5.1). Combined life expectancy at birth for males and females was 68.6 years in 2001. This is slightly below the average for CIS-7 countries (70 years), and is far below the average for the European Union (77 years). There i s a large gender gap in life expectancy, with life expectancy for Kyrgyz females being almost 8 years higher than for males. The infant, under-5, and maternalmortality rates have been steadily decreasing. Table 5.1: Main Health Status Indicatorsfor the Kyrgyz Republic,1991-2001 Indicators 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Life expectancyat birth 68.8 68.3 67.3 65.9 65.9 66.6 66.7 67.1 68.7 68.5 68.6 Female 72.7 72.2 71.7 70.7 70.4 70.9 71.4 71.2 72.6 72.4 72.5 Male 64.6 64.2 62.9 61.6 61.4 62.3 62.5 63.1 64.9 64.9 64.9 Mortalityrate 6.9 7.2 7.7 8.3 8.2 7.6 7.4 7.4 6.8 6.9 6.6 Female 6.42 6.69 7.09 7.6 7.47 6.91 6.76 6.78 6.22 6.24 Male 7.57 7.75 8.45 9.14 9.02 8.33 8.26 8.06 7.38 7.73 InfantMortality Rate(IMR) 29.7 31.5 31.9 29.1 28.1 25.9 28.2 26.2 22.7 22.6 21.7 MaternalMortalityRate (MMR) 76.4 70.1 80.1 80.1 67.4 65 76.4 54.7 45.9 46.5 49.9 Note: IMR is per 1,000 live births, and MMR is per 100,000 live births. These reportedmortality rates are basedon the definitionof live birth inheritedfrom the Soviet Union. The IMR and MMR reportedhere are useful for analysis o f trends within the country but not for comparisons with countries that use the WHO international definition of live birth. When Kyrgyzstan converts to the WHO definition, the IMR is expectedto increase by about 30-40 deaths per 1,000. Sources:National Statistical Committeeand MOHHealthInformationCenter. 58 182. The leading causes o f mortality are diseases o f the circulatory system (44 percent o f total mortality in 2000), and primarily cardiovascular diseases. This highlights the need for increased attention to health promotion actions and primary care to prevent and manage these conditions before they become severe and expensive to treat. Other major causes o f mortality include respiratory diseases (13 percent), injuries and poisoning (11 percent), and cancer (9 percent). The leading reported causes o f morbidity in 2000 were respiratory conditions (24 percent), and diseases o f the endocrine system such as diabetes (17 percent). 183. National levels o f health indicators mask important variations in health status within the country. An analysis o f Kyrgyz data from the 1997 Demographic and Health Survey (DHS) found that the infant mortality rate (IMR) was 1.8 times higher in the poorest 20 percent o f households than in the wealthiest 20 percent. Similar differences were found for under-5 mortality and nutritional status indicators.60 The official statistics also reveal significant regional variations in child health measures. For example, the IMR inBatken was 25.6 as compared to 16.6 inChui in20014 difference o f 54 percent. The difference inunder-5 mortality between these two oblasts in2000 was more than 80 percent. 184. Communicable Diseases. Trends in communicable diseases are a particular concern from a social welfare perspective because they jeopardize not only the infected individual but others in the community as well. These externalities make control o f communicable diseases a strong candidate for public action, including finance. As shown inTable 5.2, the incidence oftuberculosis (TB) andsyphilis(a risk factor for HIV/AIDS) grew rapidly in the 1990s. Among the CIS-7 countries,61 The Kyrgyz Republic has the highest reported rate o f TB. This could result in part from the fact that it i s the country that has made the greatest effort incase detectioninthis group. Table 5.2: Trends in Selected Communicable Diseases, 1991-2001 Indicators 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Tuberculosis incidence 56.9 57.9 54.5 61.4 72.4 86.9 95.3 108.9 114.4 121.8 128.4 Tuberculosis mortality rate 9.5 13.6 13.4 13.5 16.0 13.5 13.6 12.6 13.6 Syphilis incidence 2.0 2.8 4.5 22.5 73.6 152.8 167.8 144.4 116.7 73.4 49.4 NumberofnewHIVcases 0 0 0 0 0 1 2 3 4 4 134 Note: HIV data are for Kyrgyz citizens only. Sources: NationalStatistical Committeeand MOHHealthInformationCenter. 185. TB is a particular problem inthe prison system. Reportedly, the incidence rate in 2001 was over 40 times greater in the prison population than in the general population, and the mortality rate was 150 times higher. Prisons tend to be a breeding ground for multi-drug resistant TB, which poses a severe and expensive public health threat. 6oGwatkinet al., 2000. 6'The CIS-7 countriesincludeArmenia, Azerbaijan, Georgia, Kyrgyzstan, Moldova, Tajikistan, and Uzbekistan. 59 Amnesty o f prisoners due to the presence o f active TB is a common practice, and there is a great risk that the TB epidemic inprisons will spread to the general population.62 186. Table 5.2: also records the rapid growth inHIV-positive persons in2001. Inpart, this is due to better reporting. Itis also a warning sign of how this condition can grow at an exponential rate if insufficient action is taken to interrupt transmission. To date, the main risk group for contracting HIV has been intravenous drug users (IDUs). As experience in high HIV/AIDS prevalence countries such as Russia and Ukraine has shown, this i s typically the pattern o f the epidemic. Prevention and harm reduction measures are needed early on in the epidemic to prevent its spread to the general popu~ation.~~ c. STRENGTHSAND WEAKNESSES OF THE INHERITED HEALTH CARE SYSTEM 187. At independence, the country inheriteda health system with important strengths. There was an extensive network o f health infrastructure and equipment, and the medical workforce was thoroughly trained (although within a particular, treatment-oriented, doctor-centered, specialty-based approach to health care). There was a strong commitment to providing all families with equitable access to needed health care services without financial barriers to access. Health services were provided free o f charge, and there was a generous system o f social transfers and services. Health indicators were high relative to the average level o f income. 188. The inherited health care system, however, suffered from serious structural problems and perverse incentives which resulted in gross overstaffing and excessive hospital capacity - especially in Bishkek. Treatment protocols were often inappropriate, with excessive reliance on hospitalization when out-patient care was indicated, and with excessively long hospital stays.64 The health system was largely focused on specialized hospital care; preventiveand primary health care services were weak. Resource allocation was based on the recurrent input needs o f existing health facilities rather than on actual health needs. This allocation process resulted in health facilities and health personnel in urban centers receiving the bulk o fpublic resources. Clinical protocols did not reflect the latest evidence about the most effective approaches to medical care and disease prevention. The health care delivery system was unbalanced, with too many hospitals (Table 5.3) and too few general practitioners and primary care facilities. Most health programs were structured vertically and were poorly coordinated. The mix o f skills among providers emphasized specialist skills for treating "cases" over competence in family medicine and a holistic, coordinated approach to the care o f individuals. It also did not allow skilled nursingto play the expanded role that it has achieved in modern health care systems. Because primary care was relatively weak and ineffective, many medical conditions flowed through the system and were treated in hospitals-the most expensive Kokko et a]., 2002. 63Many female IDUssupport their drug habit by engaging incommercial sex work. 64Hospital stays in acute care hospitals averaged 14.7 days inthe Kyrgyz Republic in 1996/97, versus 5.0 days in Sweden and the United Kingdom, and less than 6 days in a number of other OECD countries (Making Transition Workfor Evelyone: Poverty and Inequality in Europe and Central Asia, The World Bank, 2000). 60 sector o f the health care system. Management systems for the whole sector and for individual health facilities were inadequate. More generally, the health sector allocated resources among its main subsectors inefficiently, in ways that did not achieve the maximum potential impact o f these resources on health status and outcomes. Within subsectors as well, resources were used inefficiently and failed to achieve the potential improvements in health status. The fragmented management o f health facilities led to duplication o f services and unnecessarily increased costs-a problem that was exacerbated by the government's decentralization policy. Each oblast had its own general hospital, whose facilities often duplicated facilities and services available nearby. Yet another problem was the proliferation of informal payments from health-system users as public funding became inadequate to finance recurrent inputs. The shortage o f public funding meant that patients often had to pay for drugs that were meant to be provided free, and often had to provide other inputs-such as sheets for their beds, and meals duringhospitalization-that were meant to be provided as part o f free health care. As the real salaries of health staff eroded and were often paid late, patients often had to make informal payments to physicians inorder to ensure adequate care.65 189. Underlyingmany o fthese problems o f inappropriate patterns o f care and wasteful use o f resources were the perverse incentives that health care consumers, providers, and managers faced. For consumers, health services were provided free o f charge, and there was a generous system of social transfers and services. The absence o f co-payments or other constraints on demand led to excessive demand for health services, as indicated by health care utilization rates that were very highby international standards-especially for inpatient care (Table 5.3). For providers and managers, the level o f revenue that a facility received depended on the number o f officially registered regular beds that it had. Managers could maximize their budgets by having as many full beds as possible and could minimize their costs by attracting patients who required little care. This created inappropriate incentives to retain unnecessary beds, to admit patients with little or no need for hospital care, to keep these patients hospitalized as long as possible, and to invest little effort in improving the quality, appropriateness, or efficiency o f their care. These perverse incentives also had the effect o f discouraging larger roles for public health, health promotion, primary health care, and outpatient secondary care within the sector. Table 5.3: Hospital Capacity and Use in the ECA Region Hospital beds per 1000 Average lengthof stay in days DoDulation Kyrgyz Republic 6.7 12.9 WesternEuropeaverage 3.9 6.6 CEEAverage 5.1 9.2 FSUAverage 6.9 12.4 65 Privateout-of-pocketspendingon healthnow constitutesabout 50 percent o f totalhealth expenditures in the Kyrgyz Republic. Data from household surveys show that the majority of private expenditures on health care are for ambulatory care, and especially for outpatient drugs (56 percent) (Health, Health- Seeking Behaviour and Out-of-Pocket Expenditures in Kyrgyzstan, 2001: Kyrgyz Household Health Finance Survey Final Report, Jane Falkingham,2001). 61 D. REFORMSFINANCING DELIVERYOFHEALTH IN AND SERVICES 190. These problems inthe health sector emergedas a critical constraint when transfers from the Soviet Union disappeared and when national output and public revenues collapsed early inthe transition. Inthe years following independence, the withdrawal o f subsidies from Moscow compounded the sharp fall in GDP and the shrinking size o f public revenues in relation to GDP. The contraction in public spending particularly affected the health sector. Despite this collapse o f public resources for healthcare, there was no downward adjustment in the numbers o f health facilities, beds, and health personnel to reflect the new budget reality. Health infrastructure deteriorated; salaries o f health staff declined inreal terms and were often paid late; informal payments by patients proliferated as the only means o f financing drugs and other vital recurrent inputs; and there was growing concern over the increased prevalence o f communicable diseases such as TB. 191. Under these circumstances, it was clear that the former health care delivery system was increasingly ineffective, and was unsustainable in terms o f its financing requirements. To address these problems, the government in 1996 adopted a comprehensive reform program designed to improve the resource utilization and effectiveness o f health programs throughout the country, This set o f reforms, called the Manas Health Program, introduces incentives to health providers to streamline health staffing and hospital infrastructure by replacing historical, input-based budget processes with incentive-based purchasing arrangements based on actual health care needs. It introduces hardbudgetconstraints for health care providers, and introduces incentives for providers to be efficient indeliveringhealth services. It also revises health care financing to consolidate public resources in the health sector and to pool resources at the oblast level rather than at the rayon and village level, thereby reducing fragmentation among the different sources o f revenue and improving the efficiency with which public sector resources are used. Finally, the reforms aim to improve the cost-effectiveness o f health care by emphasizing preventive and primary care over more costly specialized care, and by improving the resource allocation formula to make budget allocations on the basis o f healthneeds rather than inherited infrastructure and staffing. 192. These reforms have been successfully launched. Two o f the reforms-the establishment o f family group practices (FGPs) and a Mandatory Health Insurance Fund (MH1F)-have been adopted on a national basis. But most o f the reforms are being implementedgradually throughout the country on an oblast-by-oblast basis. The reform measures are described inthe following paragraphs. 193. Family Group Practices. The reform that has beenimplemented throughout the country involves the establishment of family group practices (FGPs) that provide integrated primary health care services. This network o f about 800 FGPs replaces the former network o f separate polyclinics for women, children, and adults; it has reduced the fragmentation and duplication that formerly characterized these services. Under the new system of primary care, FGPs simultaneously provide primary care and act as gatekeepers-making referrals as needed-for specialist outpatient and inpatient care. All citizens o f the country are entitled to free primary care as long as they seek primary care 62 from an FGP with whom they are enrolled. Referral care to hospitals is also covered, although it requires a co-payment. Inprinciple, the FGPs have autonomy to make staffing decisions and spend resources flexibly. Inreality, however, only the 500 FGPs which are contracted with the MHIF (described below) are able to exercise this flexibility, because they are paid for services on a per patient basis rather than on the basis o f inputs and thus have an incentive to combine inputs as efficiently as possible inproviding primary care. 194. HealthInsurance. The MHIFwas introducedin 1997 as an off-budget agency to mobilize additional financing for health services and to institute an insurance basis for the risk pooling of health user charges. The MHIF's revenues derive from a 2 percent payroll tax for most employees, paid by employers and collected by the Social Fund. Sources o f payments for other categories o f participants are summarized inTable 5.4. As o f 2001, the MHIF covered about 70 percent o f the population. Although MHIF financing currently accounts for a small share o f total health financing,66 the role o f the MHIF as a third-party administrator o f health care funds-as described below-is far more important than its role as an additional source of financing for the health sector. Table 5.4: Contribution Sources for the MHIF Insured Group FundingSource Workers, including Employeesin formal sector 2% payrollcontributionby employer to Social Fund Civil servants and publicenterprises 2% pabollcontributionby employer (Le. the government)to SocialFund Self-employed ~- 5% o ftotal enterpriseincometo SocialFund Private farmers 25% o fthe landtax basic rateto the Social Fund,of which 5% is for MHIF Pensioners Value of 1.5 x minimumsalary from pensionfund to MHIF Registeredunemployed Value of 1.5 x minimumsalary from unemployment fund to MHIF Childrenunder 16 and studentsunder 18 Republicanbudgettransferto MHIF Personsreceivingsocial benefits Republicanbudgettransferto MHIF 195. SinglePayer Reform. Several crucial reforms inthe financing and management of health services are under implementation in four oblasts, and are scheduled to be introduced in the remaining oblasts during the coming months.67 Although they involve several important procedural changes, these reforms are often referred to as the "Single Payer" reform, named after one o f the principal features o f the reforms. The basic features o f the reforms and the procedures which they replace are summarized in Table 5.5. These involve the following changes: e In contrast to the prior system in which oblasts, cities, and rayons purchased health services directly from providers under separate budgets for each revenue source, the MHIF now pools these budgets at the oblast level and purchases health 66In 2001, total revenues for the MHIF were 167 million som (US$3.4 million), equivalent to less than US$1per contributorperyear. 67These reformswere introducedinIssyk-Kuland ChuiOblasts in2001, and inNarynand Talas Oblasts in March2002. They were scheduledto be implementedin Bishkek in July 2002, in Osh in December2002, and inJalal-AbadandBatkenin2003. ImplementationinBishkek has beendelayed. 63 Single Payer Oblasts Non-Single Payer Oblasts Fundsfrom all local budgets (oblast, rayons, and Oblasts, cities, and rayons have separatepools of cities) for health, including categoricalgrants, funds that are usedto h n d health care. Duplication pooled within the MHIF allowing cross-subsidiesto infinancing ofservicesbetweenoblasts, cities and flow within the entire oblast rather than only within rayons. rayon boundaries.Streamlining of funding for servicedelivery across the whole oblast. MHIF uses output-basedpurchasing(capitation for Oblastsand rayonspay service providers on the primary care and case-basedpaymentfor inpatient basis of inputs, Le., the number ofhospitalsbeds care) to contractwith health providers throughout and staffing norms for the number of beds. No the entire oblast. Providers have incentivesto incentivesto improve productivity and cut costs. improve productivity, and cut costs. Providershave more flexibility inthe use of budget 1Providers exercise autonomy only over that portion funds and are able to exercisetheir autonomy to of funds received through the MHIF. No control or make allocation decisions at the facility level more autonomy over how local budget funds can be used strongly. at the facility level. Co-paymentsfor inpatient care and the Additional Formal co-payments are only applicable for the Drug Package (ADP) for outpatient care have been portion of benefits coveredby the MHIF and only formalized for the entire population. for persons insuredunderMHIF. IHospital management is consolidated within each Eachhospital is managed autonomously. oblast. For primary care, the MHIF pays contractedFGPs on a capitation basis for all insuredpersons(35 som per capita). Inthe Single Payer oblasts, these paymentsare inaddition to the 25 som paid by the oblast- level MHIF from budget funds for all enrollees. 64 196. Benefits of the Health Reforms. Even in the short time that they have been uder implementation, these reforms have begun to show benefits interms of improved efficiency, improved equity, improved transparency in managing health care, and improved healthoutcomes. The largest documentedbenefit is the sharp reduction of staff and facilities in the short time that the reforms have been under implementation. As shown inError! Reference source not found., the number of hospital beds decreased in Issyk-Kuland Chui Oblasts by over 30 percent since the introduction of the Single Payer reforms; the number of nurses and physicians declined by over 20 percent and over 8 percent, respectively. The introduction of the Single Payer reforms has also led to more adequate funding for patient costs, signaling an improved quality of care. Financing for patient costs increasedby 116 percent in Issyk-Kul(from 12-26 percent of total budget), and 87 percent in Chui (from 15 percent to 28 percent of total budget) following the introduction of the Single Payer reforms. Figure5.1: Health Capacity Reduction in Chui and Issyk-KulOblasts,2001 - v) Q) 2 40 > 38.4 0 0 s 30 ->m Q) P 20 .-g %l 10 C -a 0 0 0 numberof beds number of buildings physicians nurses I Source:SociumConsult (2002) -Draft ReportonHealthSector Reforms. 197. In addition to efficiency gains, it is worth noting the improvements in health outcomes. In 1997, Issyk-Kul Oblast had the highest IMR of any region, but by 2000 it hadthe lowest.69Evidence also suggests that the decline inIMRinIssyk-KulOblast may be the result of better clinical practices on the part of primary care physicians following the implementation of the reforms.70The Single Payer reform has also allowed health 69Subanbaev andKojakeev,2001. 70 Followingthe implementation o f the reforms, FGP physicians and nurses in Issyk-KulOblast received more training in new clinical practices than did health professionals in any of the other oblasts. Nationwide, acute respiratory infections(ARIs) are the leadingcause o f infant mortality,comprisingabout 35 percent o f deaths. A survey of patient records undertakenin 2001-02 comparedtreatment practices of FGPs in four regionsto new clinicalguidelinesfor the management o f ARIs. This survey found that FGPs in Issyk-Kulwere in compliancewith treatment guidelines in about 95 percent o f cases, as comparedto 44 percent in Bishkek, 54 percent in Chui, and 78 percent in Osh. This suggests that clinical practices of primarycare physicians in Issyk-Kulmay be better than in other regions-at least for the management of ARIs. While this doesnot provethat the primarycare reformswere the causeof infant mortalitydecline, it doesgive cause for optimismthat the FGP reformandretraining ofphysicians is having a positiveeffect on healthoutcomes. 65 spending and health services to target the poor. By pooling all local budget revenues at the oblast level, the potential for risk protection for the population has been greatly enhanced. Moreover, the establishment o f higher payments for persons in exempt categories has enabled subsidies to be targeted to individuals in these groups.71 The introduction o f co-payments under the reform program has led to improved transparency in financial obligations for patients by reducing uncertainty about the costs of inpatient health care.72 It also appears to have largely succeeded in replacing informal payments with formal ~o-payments.~~ 198. Threatsto the ReformProgram. Although the Manas HealthProgram has been officially adopted by the government as national policy, and although Bishkek Oblast was scheduled to implement the reforms starting in July, 2002, Bishkek has to date declined to implement the reforms. Unless Bishkek participates in the reforms, not only will the extension o f the reforms and their benefits to the rest of the country be prevented, but the progress made inthe four participating oblasts mightbe reversed. This i s an urgentmatter calling for government leadership at a highlevel to bringabout Bishkek's full compliance withthe SinglePayer reform program. E. HEALTH EXPENDITURES 199. Level o f Health Expenditures. As shown in Table 5.6, total public spending on health in the Kyrgyz Republic has declined very sharply as a percentage o f GDP since 1995. The current health allocation o f 1.9 percent o f GDP leaves the health system seriously under-resourced, and leads to ineffective, inequitable, and inefficient health 71Hospitalshave set aside 10 percent of their co-paymentrevenues intheir "reserve funds" to provide free drugs for locally identifiedpoor patients who lack documentationof any right to exemption. From March to December 2001, about 9.5 percentofpatients inChui and Issyk-Kulreceivedfree treatment, o fwhom 57 percent were exemptedbecause o f their personalor disease characteristics, with the remaining 43 percent given care at the expenseof hospitalreservefunds (Ibraimova 2002). 72About 17 percent of the respondentsto a baselinesurvey in the two Single Payer oblasts had an idea of the total amount that they would have to pay prior to their hospitalization, and about 25 percent o f the respondents inthe other oblasts reportedhavingsuchknowledge. The resultso fthe follow-up survey show a dramatic improvement in knowledge (reduction o f uncertainty) in Chui and Issyk-Kul. Therefore, knowledge of the total amount to be paid increasedto 46 percent o f patients, whereas there was a slight decrease inthe other oblasts. These findings suggest that, even after only five months of implementation, the efforts of the MOH to inform the population about the new policy had reduced uncertainty substantially. The survey-basedevidence presentedhere is drawn from Kutzin(2002). The WHO surveys of hospitalpatients implementedby the NSC includeda baselineof2,917 patients nationwide discharged in February 2001 (the month prior to the implementation o f the co-payment in Chui and Issyk-Kul) and a follow-up survey o f 3,73 1patientsdischarged inJuly. These constituted7.4 percentand 9.9 percentofthe inpatient populationineach month, respectively. 73 Follow-up survey results indicate that in Issyk-Kul Oblast, with the exception of the value o f food brought for the hospitalization, the policy was remarkably successful in terms of replacing informal paymentswith the formal co-payment. Expendituresspecifically for drugs and medical supplies declined by 92 percent. Payments made directly to staff were also reduced by over 70 percent. The total levelof patient expenditure was about the same before the co-payment as after, suggesting a transformation of informalpayments into a formal contribution and the effective use of these revenuesby hospitals. This is further supportedby data from the MOHwhich indicatethat, as a consequence of the co-paymentrevenues and restructuring, average drug expendituresper patient-day in Issyk-Kulhospitals increasedby 2.5 times andaverage staffsalaries increasedby 24 percentrelativeto 2000 levels (Ibraimova2002). 66 care. It leads to ineffective health care by failing to provide the essential drugs, health supplies, and other inputs. It leads to inequitable health care because it necessitates informal payments-an extremely inequitable form o f financing-to help fill the financing gap. It leads to inefficient health care because it prevents the investments that are necessary to reduce future budgetcosts - for example, to carry out hospital consolidation so as to reduce staffing and facilities, and to insulate health facilities to make them more fuel-efficient. This level o fpublic expenditure for healthputs the country inthe company o f the poorest developing countries such as Haiti and Congo, which devote a similarly low percentage o f GDP to the health sector. Average levels are 6.2 percent inthe OECD, 5.1 percent in Central Europe, and 3.6 percent in the CIS.74 The most important asset that the Kyrgyz Republic inheritedat independence was a population that benefited from heavily subsidized expenditures for health and education. Failure to devote a larger share o f GDP to maintaining and improving the health status in the country risks wasting this advantage and progressively losing ground to countries that invest more aggressively in the healtho ftheir population. Table 5.6: Public Spendingon Healthin Relationto GDP, 1995-2001 1995 1996 1997 1998 1999 2000 2001 Total, YOof GDP 4.0% 3.1% 2.8% 2.8% 2.4% 2.0% 1.9% State budget 4.0% 3.1% 2.7% 2.7% 2.2% 1.9% 1.8% MHIF 0.0% 0.1% 0.2% 0.2% 0.2% Sources: Treasury data for state budget health spending, MHIF for MHIF expenditures from revenues receivedfrom the Social Fund, and National Statistical Committee for GDP data. Budget health spending dataexcludethe PIP. 200. Sources of Funds. The Kyrgyz health sector i s financed from six sources: (i) line-item allocations in the republican budget for public health programs (such as the Sanitary Epidemiological System, immunizations, and the national TB control program) and republican health institutions (such as teaching hospitals in Bishkek and medical research institutes); (ii)categorical grants to oblasts from the republican budget, intended to cover basic education and health services; (iii) governments' own revenues; (iv) local employer contributions and the other prescribed contributions to the MHIF; (v) out-of- pocket expenditures by users for official co-payments and informal charges and payments; and (vi) the foreign-financed public investment program (PIP). The composition o f health expenditures in terms o f these sources o f financing i s shown in Tables 5.7 and 5.8. Private payments account for half o f total health sector expenditures. Budget expenditures account for most of the rest, o f which the republican budget, local revenues, and categorical grants contribute roughly equal amounts. l4WorldDevelopmentReport, 2000/2001. 67 Table 5.7: Health Expenditures by Source, 2000-01 2000 2001 Total health spending, YOGDP, ofwhich 4.35% 4.03% Budget (Republic & local) 1.88% 1.78% ForeignFinancedPIP 0.12% 0.04% MHIF 0.16% 0.16% Private out-of-pocket spending 2.19% 2.05% Percent of total health spending Budget 43.3% 44.2% ForeignFinancedPIP 2.8% 0.9% MHIF 3.7% 4.0% Private out-of-pocket spending 50.2% 50.8% Per capita health spending Som Dollars Som Dollars Total 578.9 $12.1 601.4 $12.4 Budget 250.4 $5.2 265.8 $5.5 Foreign FinancedPIP 16.5 $0.3 5.6 $0.1 MHIF 21.3 $0.4 24.2 $0.5 Private out-of-pocket spending 290.7 $6.1 305.6 $6.3 Note: Expendituresare measured interms of the source of funds. "Budget" reflects all health expenditures coming from budgetarysources, including expenditures made by the MHIF with funds transferred from the republican budget and by the oblast offices of the MHIF, with funds transferred from local budgets. "MHIF" reflects only those expenditures derived from revenues transferred to the MHIF from the Social Fund. Source: Treasury data. Budget funds include republican budget (line-items and categorical grants) plus local budgets. Table 5.8: Local and Republican Shares of State Budget Health Spending, 1995-2001 1995 1996 1997 1998 1999 2000 2001 Republican Budget 23.8% 28.3% 33.9% 31.8% 32.2% 33.3% 31.6% Local Budget 76.2% 71.7% 66.1% 68.2% 67.8% 66.7% 68.4% categorical grants 31.1% 31.4% 31.0% 24.2% 31.8% local means 76.2% 71.7% 35.0% 36.7% 36.8% 42.5% 36.6% Source: Treasurydata. 201. Private out-of-pocket spending on health constitutes about 50 percent o f total health expenditures in the Kyrgyz Republic.75 Incomparison with other CIS-7 countries such as Georgia (87 percent) and Tajikistan (70 percent), the Kyrgyz Republic has a relatively low share o f out-of-pocket spending. Informal payments in the health system typically signal systemic problems such as an oversupply of health personnel, low levels of public financing and low wages for health personnel, lack o f funds for variable inputs (medical supplies), and corruption and lack o f transparency in the health system. The health sector reforms have sought to address the problem o f informal payments by ''Data from household surveys show that the majority of private expenditures on health care are for ambulatory care, and especially for outpatient drugs (56 percent). 68 package financed through public funds.7 introducing formal co-payments for in9atient and ambulatory care under the benefits 202. MHIF receipts currently account for only 4 percent oftotal health spending, or 9 percent o f total budget spending for health. There i s a serious problem o f capture o f MHIF contributions by the collection agency (Table 5.9). The Social Fund collects almost three times this amount from employer contributions to the MHIF, but keeps two- thirds o fthis amount to helpmeet the deficit inthe PensionFund. Social Fundarrears to the MHIF have been growing each year. In 1997 the Social Fundhad arrears o f only 46 million som to the MHIF; in2001,the arrears had increased to 470 million som. This i s an inappropriate diversion o f these funds, one which undermines the insurance basis o f the MHIF and contributes to the underfunding o f health services. The employer contributions and other payments made under the MHIF should be fully passed on to the MHIF. Table 5.9: RevenueTransfers to the MHIFfrom the Social Fund and RepublicanBudget, 1997-2001 1997 1998 1999 2000 2001 Percentof collections/budgetstransferredby the Social Fund Employees 22.4% 37.3% 62.4% 64.6% 48.3% Pensioners 0.0% 25.8% 30.2% 26.1% 9.8% Registeredunemployed 15.3% 66.7% 34.4% 27.8% Total "transfer rate" from the Social Fund 16.4% 32.5% 53.8% 53.8% 35.5% Percent executionof Republican Budget transfers Children 72.9% 53.1% Persons receiving Social Benefits 84.0% 60.5% Total budget executionrate 74.3% 53.7% Total MHIFtransfer/executionrate 16.4% 32.5% 53.8% 57.2% 38.5% Source: MHIF data. 203. There i s also an issue o f local governments' expenditures for health. Local governments inthe Single Payer oblasts reduced their health expenditures substantially in 2001 compared with the other oblasts. Reportedly, the perceived success of the Single Payer system inimproving transparency inpatient contributions led local governments to reduce their budget allocations to health, owing to the apparent increase in funding coming from this source. Co-payments are not an additional source of funding for the health sector, but rather a transformation o f informal payments into a more transparent and more desirable form o f payment. To the extent that local governments reduce their budget allocations to the health sector in response to data on co-payment collections or reductions in building and staff, they are effectively penalizing the success o f the health sector in improving equity, efficiency, and transparency in the management o f public resources for health care. This action fundamentally undermines the reform. It also has negative implications for corruption and equity, since it induces providers to revert to For inpatient care, patients are charged a flat rate of 570 som (for persons insured under the MHIF), 1,140 som for uninsured persons, 190 som for partially exempt individuals, and no co-payment for those fully-exempt. The outpatient drug benefit covers drugs needed to enable effective outpatient treatment for diseases that are responsible for a high disease burden in the population (e.g., hypertension). The drug benefit involves contracts between the MHIF and pharmacies and helps improve quality assurance for drugs and helps curb informal markets. 69 informal patient contributions to bridge the gap created by reduced public funding. International experience demonstrates clearly that out-of-pocket payment i s the most regressive form o f payment for health care. It also poses a financial barrier to access to care, a barrier that i s more difficult for the poor to overcome. 204. Budget and Payment Process. The Ministry o f Health (MOH) has no direct involvement in the oblast budgetary process, although the national budget planning process between the Ministry o f Finance and the MOH sets the national framework. At the oblast level, oblast committees prepare a budgetproposal that includes inputs from all health facilities. The proposal i s discussed with the oblast finance department and, once agreed, i s included in the oblast's consolidated budget submission to the Ministry o f Finance. The amounts ultimately approved by the Ministry o f Finance are typically less than the amounts requested. Inthe non-Single Payer oblasts, health budgets are based in principle on the budgetline items for the previous year (originally based on infrastructure norms), and payments are made by the oblast health department directly to health providers. Inthe Single Payer reform oblasts, healthbudgets are based inprinciple on the agreed capitation and case-based amounts; the oblast finance department allocates budgetedfunds to the oblast-level MHIF,77which pays providers. When actual budgets fall short o f these needs, informal payments and arrears fill the gap. 205. Under the government's decentralization program, local governments were meant to finance basic education and health service provision from their own sources. But local revenues proved insufficient to maintain basic education and health services in all but a few localities. Deteriorating quality and accumulating arrears in staff salaries signaled the urgent need for central budget support to supplement local resources in financing these services. To respond to this problem, the government in 1997 introduced categorical grants for oblasts; these were specifically designed to ensure that local governments had the resources to at least meet minimum service standards for basic education and health services at the local level. The categorical grants were intendedto be provided on a capitation basis, which would have provided an incentive for the rationalization o f infrastructure and staffing for basic education and health. Payment amounts under the categorical grants were intended to reflect the costs o f providing minimumservices to age and geographic groups for which the cost of provision differed. But the health sector was not ready to define minimumservice levels at the time that the categorical grants were introduced. At the same time, the sharp compression o f domestic spending was generating major wage arrears in the health and education sectors. There was strong political pressure to find a solution which would ensure timely payment o f salaries. As a result, the categorical grants were used to pay salaries to education and health staff at the local level, rather than to ensure a minimumservice level. 206. How have the categorical grants affected health? The earmarking o f the categorical grants for specific purposes has effectively meant that the bulk o f education and health expenditures were recentralized, even though the grants were paid through the oblast finance departments. Because staffing and wage bills largely reflectedthe existing 77In the Single Payer oblasts, the oblast-level branch of the MHIF replaces the oblast-level health department. 70 infrastructure at the local level, the categorical grants reinforced prior inefficiencies rather than providing an incentive for improved efficiency, as intended. Moreover, because categorical grants were linked to staff salaries, which were falling steadily inreal terms, the grants themselves have fallen inreal terms since their introduction. 207. The Health Expenditure Mix. The country's epidemiological situation, as well as its stated health policies, call for a shift in resource allocation away from specialized and inpatient services toward primary care and public health services. Yet, as Table 5.10 shows, hospitals continue to consume the bulk o f public spending on health care (72.3 percent in2001); this percentage has changed very little inthe last six years. Ambulatory care consumes only about 10 percent o f health expenditures, while the remaining 20 percent i s dividedamong public health activities. Table 5.10: Distribution of State BudgetHealthSpending, by Program, 1995-2001 1995 1996 1997 1998 1999 2000 2001 Wide profile (child and adult general) hospitals 53.3% 52.3% 48.6% 49.1% 47.6% 51.0% 50.2% Specialty hospitals 14.5% 15.6% 18.2% 19.7% 21.3% 19.9% 19.8% Maternity hospitals 3.8% 3.1% 3.0% 3.4% 3.2% 2.5% 2.0% Rehabilitation hospitals 0.0% 0.0% 0.1% 0.0% 0.0% 0.0% 0.2% Other hospitals 0.2% 0.3% 0.2% 0.2% 0.2% 0.2% 0.1% Hospitalsub-total 71.7% 71.3% 70.2% 72.5% 72.3% 73.6% 72.3% General polyclinics & OPD physicians 7.9% 8.0% 7.5% 7.3% 8.0% 7.7% 7.9% Specialty polyclinics and specialty physicians 0.2% 0.2% 0.2% 0.2% 0.3% 0.1% 0.0% Dental polyclinics 1.2% 1.3% 1.1% 1.1% 1.1% 1.1% 1.0% Ambulance stations 1.0% 1.1% 0.9% 1.0% 1.1% 1.0% 1.1% Ambulatory care sub-total 10.3% 10.6% 9.7% 9.5% 10.5% 10.0% 10.1% Public health (SES, etc.) 7.1% 6.8% 6.5% 5.7% 6.1% 5.7% 5.6% Other 10.9% 11.3% 13.6% 12.3% 11.1% 10.7% 12% ConsolidatedBudgetary HealthSpending 100% 100% 100% 100% 100% 100% 100% Note: Data include non-MOH as well as MOH health mendine. Percents exclude sDecial means and transfers to the MHIF. Beginning in 1999, centralized utility costs for the republican level are attributed to I national hospitals and research institutes in proportion to their other costs. "Other" expenditures include Department of Drugs and Supplies (beginning 1997), Republican Immuno-Prophlaxis Center, Medical Information Center, and a variety o f other centralized units ofthe MOH. Source: Kyrgyz GovernmentTreasury data. 208. Analysis o f health expenditure data by line item or "chapter" (Error! Not a valid bookmark self-reference.) shows that a large percentage o fpublic resources are spent on fixed costs, namely personnel and utilities. Corresponding to the high percentage o f expenditures on fixed items are the low shares devoted to patient treatment items, particularly drugs and medical supplies. In 2000 and 2001,utility expenditures reached over 20 percent o f total public spending on health care, and are likely to rise further as energy prices are liberalized unless investments are made to improve the energy efficiency o f health facilities. The extremely low percentage o f health spending on capital investments i s o f concern. It not only signals the absence o f investments to reduce recurrent costs through improved energy efficiency and other measures, but it also reflects the increased dependence o f the health sector on donor funds for the upgrading and renewal o f buildingsand equipment-a dangerous trend. 71 Table 5.11: Distribution of State Budget Health Spending by Category, 1995-2001 1995 1996 1997 1998 1999 2000 2001 Total Recurrent Expenditure 91.0% 90.9% 91.7% 93.7% 94.9% 94.1% 94.6% Personnel-relatedexpenditures 56.3% 51.6% 52.3% 51.8% 56.4% 50.5% 52.5% of which, Ca?egoricaIgrants 0.0% 0.0% 59.7% 61.0% 55.2% 49.6% 62.2% Travel expenses 0.2% 0.2% 0.2% 0.3% 0.3% 0.4% 0.2% Pharmaceuticalsand supplies 8.4% 9.8% 2.7% 12.0% 12.0% 9.3% 9.4% Food 8.3% 9.0% 8.3% 10.0% 8.5% 9.0% 9.1% Utility costs (heat, electricity, gas, phone) 12.4% 15.5% 3.7% 15.4% 14.0% 21.3% 20.2% Hiring and maintenanceof vehicles 2.5% 2.0% 1.8% 1.8% 2.0% 2.2% 1.9% Other purchases and services 3.1% 2.9% 2.9% 2.7% 2.0% 1.8% 1.4% Total Capital Investment 9.0% 9.1% 8.3% 6.3% 5.1% 5.9% 5.4% Equipment and materials 2.1% 2.1% 2.0% 1.7% 1.5% 1.5% 0.9% Buildings, facilities, other civil works 4.4% 4.8% 3.4% 1.7% 1.5% 1.5% 2.1% Capital renovation 2.5% 2.2% 2.8% 2.9% 2.0% 2.9% 2.4% Total Expenditures from Budget 100% 100% 100% 100% 100% 100% 100% Note: The percentagedistribution across line items excludesexpenditures from special means and transfers to the MHIF. Personnel-relatedexpendituresinclude salaries and Social Fund contributions. 209. Regional Distribution of Health Expenditures. Geographic allocation of resources in the Kyrgyz Republic i s not based on need (levels of poverty, health needs, and population dynamics). Under the inherited system, input-based funding meant that those regions o f the country that had the highest numbers o f health facilities and personnelreceivedthe greatest amount of funds. Historically, Bishkek, whichhas a large number of health institutions (providers of medical care, research institutes) has received the greatest amount of funds from the republican budget. For example, while the average per capita allocation from the republican budget for all of the Kyrgyz Republic is 204 som, the allocation for Bishkek is 607 som (almost 3 times higher than the country average) and the allocation for all the other oblasts is between 121 and 175 som (1998 figures). 210. Differentiation of Health Payments by Cost Categories. As described above, a major innovation under the health sector reforms has been the introduction of new payment methods for providers. These payment methods are currently applied to all MHIFcontractswithhealthproviders. For primary care, the MHIFpays contractedFGPs on a capitation basis for all insured persons (35 som per capita). In the Single Payer oblasts, these payments come in addition to the 25 som paid by the oblast MHIF office from budget funds for all enrollees. However, although the capitation formula was meant to distinguish differential costs of provision by age, sex, and geographic location of patients (and to provide an economic adjustment factor designed to reflect need), it has not done this. Thus, there is no system in place as yet for compensating providers for higher-cost categories o f users (e.g., children, the elderly). For inpatient care, the MHIF has developed a system in which hospitals are paid a lump sum for each type of case treated. The national per case base rate for insured persons i s 350 som; in the Single 72 Payer oblasts, the base rate per case from budget funds (TDMHIF) i s 750 som. The case- based payment system embodies the concept of output-based payments and improves the efficiency incentives for providers. But it also has a tendency to increase hospital admissions-a problem which is being addressed by the MHIF through instituting spendinglimits. F. RECOMMENDATIONS 211, The following actions are recommended as means o f improving the efficiency and effectiveness o f health services, based on the findings described above: Increase public budget support for health care. In order to improve the effectiveness, efficiency, and equity o f health services, public budget support for health programs needs to be increased. As a target for the increased public funding of health programs, it is recommended that combined local and republican budget expenditures for health be increased to about 4 percent of GDP-the level prevailing in 1995. 0 Improve the energy efficiency of the health infrastructure. New investments are needed to reduce future recurrent costs by improving the energy efficiency o f health facilities. It i s recommended that investments be made in better insulation for the exterior walls o f these facilities and heat delivery networks, that meters be installed to monitor the consumption o f energy, and that the feasibility o f solar heating be considered. Inoblasts already implementingthe Single Payer system, and where restructuring o f health facilities i s advanced, these investments can be made almost immediately. The financial incentives created by the Single Payer system have created the motivation for investmentsto improve energy efficiency. As the necessary financial resources become available inthe Single Payer oblasts, itis expected that these investmentswill be made. 0 Improve transparency and distribution equity in allocating public funding for health care. The process o f determining budget allocations for health care needs to be revised in order to reflect needs and capacities rather than to simply fill the gap in meeting personnel-related costs. It is recommended that a new basis be developed for determining the amounts o f categorical grants for health care on needs-based criteria rather than on the basis o f the costs o f maintaining existing staff and facilities. Unless this is done, the health sector will have little incentive for generating additional sources for its revenues, reducing informal payments, and rationalizing staff positions and personnel. 0 Improvethe predictabilityof the flow of funds for healthcare. The incentives for improved efficiency and the capacity to improve distributional equity under the Single Payer system are contingent on the adequate and timely flow o f funds. This has been jeopardized by the reduction of budget allocations to oblasts implementingthe Single Payer reform as co-payments replace informal payments under the reform, and by the capture o f MHIF revenues by the Social Fund. The capture o f MHIF revenues by the Social Fundalso undermines the integrity o f the 73 insurance principle underlyingthe MHIF. Inorder to address these problems, two actions are recommended. First, legal or other sanctions should be adopted to establish the principle that oblasts implementing the Single Payer reforms will not incur budget reductions as formal co-payments replace informal payments. Second, the government should enact legislation (or a Presidential Decree with the force o f law) that requires the Social Fundto pay to the MHIF, with a delay not to exceed one month, all revenues for health that are collected by the Social Fund as health insurance contributions and, in addition, all health insurance contributions payable by the Pension Fund and Employment Fund on behalf o f pensioners and the ~nemployed.~'In the event that organizational responsibility for the collection o f health insurance contributions i s changed, an equivalent obligation should apply to the organizationnewly acquiring that responsibility. e Implement the Single Payer system on a nationwide basis. The Single Payer approach i s a comprehensive health financing reform that addresses many o f the major shortcomings o f the previous system, as described above. It i s a crucial requirement inproviding the incentive to providers to "right-size" health facilities and inbringing about the neededreductions inthe number o f health personnel. It i s also crucial to improving the distribution o f public resources for health care. The Single Payer system is currently operational inonly four oblasts. Nationwide implementation, especially in Bishkek City, i s needed in order to obtain significant benefits in the rationalization o f health facilities and personnel. Concerted support is needed from the highest levels o f government for nationwide implementation of the reform. Nationwide compliance with the Single Payer reform needs to be grounded in permanent legislation rather than in temporary implementation decrees. e Address emerging public health challenges. There is an urgent need to accelerate programs to tackle the growing problems o f TB and HIV/AIDS, especially among the prison population. For HIV/AIDS, there i s a need to expand harm reduction strategies to cover at least 60 percent o f the risk groups. For TB, there i s a need to develop a comprehensive program for the detection and management o f this disease, ensuringan adequate drug supply, training staff, and instituting a system o f follow-up with patients. It i s also recommended that the government consider suspension o f its amnesty program for prison inmates with TB. This amnesty program creates perverse incentives for contracting TB, as well as serious public health risks for the public. These actions will have implications for financing. Although donors can be expected to provide support for TB and HIV/AIDS, the issue o f sustainability interms o f public funds and the reduction o f donor dependency needs to be addressed. The first step i s to identify the "financing gap'' by funding an enhanced program for. controlling TB and 78An alternative to requiring the Social Fundto make timely payments o fthe health insurance contribution for pensioners and the unemployed would be to: (i)eliminate the current obligation on the Pension Fund and Employment Fund to pay health insurance contributions to MHIF on behalf o f pensioners and unemployed people; (ii) concurrently raise the health insurance contribution rate by an amount sufficient to achieve the same overall revenue flow to MHIF; and (iii)concurrently reduce the pension insurance and employment insurance contribution rates by an amount sufficient to lower their revenue flows accordingly. 74 HIV/AIDS, and ensuring that over the medium to long term public sector resources are available for these priority public health interventions. Reform o f the Sanitary Epidemiological System, in its mandate to improve disease surveillance and monitoring, i s needed, as i s ensuring the continuous supply o f drugs. 75 I I I I I E CI I II s1 I ; I O I .II I I ................. , I I ~ I ij scg : j I n i1 E-c I 18 % j ~ I j v j i............... : I II I 1U I I I ,................ I ; n / i I i E 1 ~ I 1s ~ I ................. I I ................. 1 I I I I I .................... I I c - 0 a s I I M I I $e-. p u z I I ................... ..................... I I I I I I I I I I I I I Ir .... .... I I 6. EDUCATION A. INTRODUCTION 212. This chapter presents issues and recommendations for the education sector inthe Kyrgyz Republic. The section that follows describes the inherited education system at the start of transition, the challenges arising for the transition itself, and recent policy initiatives inthe sector. Section C describes the performance of the education system in terms of coverage and quality; it outlines the reforms that the government has proposedto address the outstanding issues in the sector. Section D summarizes the key issues in education finance and management, and Section Epresents recommendations designedto improve the quality, equity, and efficiency of expendituresinthe education sector. B. TRANSITIONCHALLENGES 1. Population 213. Kyrgyz Republic's population of 4.9 million is predominantly ethnic Kyrgyz, but includes significant ethnic and linguistic minorities ofRussian, Uzbek, Tajik, andTurkish population (Table 6.1). Major emigration after independence reduced the share of the Russian population from 21.5 percent in 1989 to the current 12.4 percent. Unlike the situation inmost of the FSU, inthe Kyrgyz Republicthe population i s growing, at about 1.1 percent per year.79 This also means that the country has a younger population than most of the FSU countries, with 45 percent of the population 19 years old or younger versus 26 percent inthe Russian Federation and similar levels inthe other CIS countries. Whereas the school-age population in Russia and the CIS is shrinking rapidly and will continue to shrink for the foreseeable future, the size of the school-age cohort in the Kyrgyz Republic i s stable. The size of the compulsory education age group-from 7 to 15 years old-is projected to decline only very slightly durin the first five years o f the decade, from 1.053 million in 2000 to 1.020 million in 2005." But although the overall size of the school-age cohort is stable, population movements within the country are leading to a demand for additional school capacity in some localities, and to excess capacity inothers. ''According ~~ to the results o fthe 1999 Population Census and the 1997 Demographicand Health Survey, the population growth o f 1.1 percentresults from a 1.4 per cent rateo fnatural increase(births minus deaths), and a net out-migration o f 0.3 percent per year. World Bank projection. 77 Table 6.1: Ethnic Composition and RuralNrban Status of Population by Oblast Population % Urban Kyrgyz Uzbek Russian Other Kyrgyz Republic 4,850,734 35.3% 64.5% 13.7% 12.4% 9.4% Batken 380,142 19.6% 74.7% 14.5% 2.2% 8.6% Jalal-Abad 869,539 23.4% 69.8% 24.4% 2.1% 3.7% Issyk-Kul 415,513 30.6% 79.0% 0.8% 13.1% 7.1% Naryn 248,699 18.5% 98.9% 0.5% Osh 1,176,646 23.5% 63.8% 31.1% 1.3% 3.8% Talas 200,269 16.9% 88.4% 0.9% 4.0% 6.8% Chui 772,188 21.9% 43.7% 1.6% 31.8% 22.9% Bishkek 787,738 99.4% 50.5% 1.6% 32.1% 15.8% Source: ThePopulation of Kyrgyzstan,National Statistics Commission, Bishkek, 2002. 214. One of the particular challenges o f education delivery i s the high proportion o f rural population. Inthe aggregate, 65 percent of the Kyrgyz Republic's population lives inrural areas-mostly inmountainous areas. InNaryn and Chui Oblasts, more than 80 percent o f the population i s rural. This situation presents a challenge in terms o f both delivery o f education and demand for education. It complicates delivery and raises education costs because the greater dispersion o f population in rural areas leads to smaller class sizes, to smaller school sizes, and often to lower teacher utilization rates. Rural location also affects the demand for and quality o f education because: (i) poverty i s more widespread in m a l areas and i s such that many families cannot afford the costs o f textbook rental, school supplies, andpresentable clothing for their children; (ii) the public revenue base is much smaller in rural areas, so that many local governments cannot finance school inputs beyond the meager inputs financed through the republican budget; (iii)rural schools are generally more poorly equipped and maintained than urban schools;" (iv) rural parents have lower levels of educational achievement than urban parents and rural households offer fewer educational stimuli and resources than urban households; and (v) school-age children inmany rural households miss part o f the school year because they need to participate in seasonal agricultural labor in order to contribute to householdincome. 2. The InheritedSystem 215. The Kyrgyz education system comprises pre-school education for children between 1 and 6 years of age, primary education (grades 1 through 4), lower secondary education ( rades 5 through 9),upper secondary education (grades 10 and 1l), and higher education. S f Inaddition to the formal sector, there are numerous out-of-school institutions 81The National Survey o fPrimary Education Quality, which was carried out inNovember 2000, found that 28 percent o f rural schools lacked electricity, 45 percent lacked adequate heating, and 78 percent lacked adequate furniture (Monitoring Learning Achievement: National Survey of Primary Education Quality MEC, UNICEF, UNESCO, and the Center for Opinion Study and Forecasts, Bishkek, 2001). 82The initial years of formal education in the Kyrgyz Republic are referred to as "secondary education." Initial schools offer grades 1 through 4. Basic schools or "incomplete secondary schools" offer grades 1 to 9. "Complete secondary schools" offer grades 1 through 11. For clarity, we use the more conventional 78 and organizations to meet the education and training needs o f the population. Specialized schools within the public education system provide instruction in each o f the major minority languages. Kyrgyzstan entered the transition with relatively high levels o f educational participation. 216. Under the former Soviet system, the Kyrgyz education system benefited from centrally developed curricula, teacher training, textbooks, and educational materials. The system was sustained at a relatively highlevel o f coverage and performance by direct and indirect subsidies o f many kinds fiom the more prosperous Soviet republics. Education was free at all levels and compulsory through grade 10. But curricula and teaching methods at all levels were dominated by ideology and denied any questioning and critical thinking. Teaching was teacher-centered, and emphasized repetition as evidence of mastery. Students were not encouraged to be inquisitive, or to apply concepts to real-life applications. The bulk o f enrollments at the secondary level were innarrowly specialized academic, technical, and vocational programs that conveyed a static set o f skills for a specific occupation. Access to higher education was very limited, with fewer than one- fifth of secondary school graduates going on to higher education. Programs in higher education concentrated on science and engineering, with few offerings in the social sciences and humanities. Virtually all studentswere assured o fjobs at the completion o f their secondary or higher education studies, and they could expect to keep these initial jobs throughout their working lifetimes. 217. The dissolution o f the Soviet Union and the expanded role of competition led to pervasive changes instructure and performance o f the Kyrgyz economy. National output declined by 50 percent between 1990 and 1995 and recovered only very slowly thereafter (Figure 6.1). By 2000, real GDP was just 64 percent o f its level in 1990.83 Public revenues declined even more sharply. The greater reliance on markets led to the bankruptcy o f some state enterprises and shifted others to private ownership and management. 218. The transition also led to fundamental changes in the education system. Many people questioned the utility o f education when graduation no longer led to assured employment, and when many families needed the contribution o f all household members inorder to sustain themselves. Lacking the resources to maintainthe education system as it had been, the government reduced the duration o f compulsory educationto nine years, shifted much o f the responsibility for financing public primary, secondary, and higher education to local governments and parents, and authorized schools to raise money from the rental of facilities and other activities, Students were required to purchase or rent textbooks, which formerly had beenprovided free.84The government also encouraged the terminology o f primary education to refer to the compulsory initial 9 years o f formal education, and secondary to refer to grades 10 and 11, including generaland vocationalltechnical education. 83World Bank SIMA database. 84By comparisonto the minimum monthly salary in 2000 of 220 som, a set of textbooks costs 160 som for grade 1, 220 som for grade 5, and 430 som for grade 11, and a school uniform costs 240 to 480 som (Educational System of the Kyrgyz Republic: Current Status and Developmental Pathways in 1991-2001, Ministry of Education and Culture, Bishkek, 2001). 79 private provision o f education at all levels, and instituted a system o f contracted, fee paying education within public universities and specialized upper secondary schools- essentially creating a segregated system o f private instruction within ostensibly public educational institutions. As described below, central budget resources have managed to keep the existing primary and secondary schools and higher education institutions alive, but only barely. The quality o f education has declined seriously inall schools except the few urbanschools that benefitfrom significant parental and community contributions. 3. TransitionChallenges Figure 6.1: Evolution of Real GDP, 1990-2000 (inmillions of 1995 som) 33,000 31,000 29,000 27,000 25,000 23,000 21,000 19,000 17,000 15,0004 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Source: World Bank SIMA database. 219. These changes in economic and political life called for equally fundamental changes inthe mission and content o f education programs. The content and delivery o f education programs at all levels neededto change inorder to provide an unbiased view of knowledge, and to develop students' capacities incritical thinking. The education system needed to adapt to a new situation in which the traditional areas of employment for graduates were collapsing or were changing fundamentally, and needed to do so in a situation o f shrinking resources. Rather than imparting specific occupational skills, basic education needed to provide a foundation o f basic skills in literacy, numeracy, communications, teamwork, and problem solving, which could ensure that specific skills for particular jobs could be imparted through new programs o f lifetime learning-often, inthe workplace itself. The content of education and training needed to become more flexible andmore responsive to labor-market needs. Teaching methods needed to become more student-oriented, and to focus on teamwork, on the application o f concepts and synthesis o f material across disciplines, and on the ability to access information. Programs needed to be expanded in the social sciences, the humanities, and new areas demanded by the global economy-including business administration, economics, and foreign languages. 80 C. PERFORMANCETHEEDUCATIONSYSTEM OF 1. EducationCoverage 220. As shown in Table 6.2, the largest changes inenrollments occurred in pre-school and higher education. Recorded enrollments in pre-school education declined precipitously throughout the 1 9 9 0 ~with ~ virtually all o f the decline occurring in schools managed by ministries other than the MEC. Enrollments in higher education more than doubled. Enrollments in primary and secondary education increased at an average o f slightly under 2 percent per year, with an initial decline in enrollments in grades 5 through 9 and a rapid recovery in the latter years o f the decade. At the same time, university enrollments increased significantly-from 10.8 percent o f the age group in 1990 to 15.2 percent in 1998, largely because o f the increase in enrollments in private institutions. Table 6.2: Enrollments by Level, 1992/93-2000/01 Pre-school Grades Grades Grades Total Higher 1-4 5-9 10-11 Grades 1-11 Education 1991/92 190,100 1992193 143,200 367,000 458,500 114,000 939,500 38,414 1993194 92,200 378,900 454,400 101,000 934,300 38,384 1994195 58,900 386,200 460,800 97,800 944,800 39,902 1995196 46,100 471,900 402,900 95,900 970,700 47,416 1996197 47,300 475,800 425,000 105,400 1,006,200 53,102 1997198 46,100 472,100 446,700 121,100 1,039,900 63,498 1998199 46,600 470,700 467,5 00 140,400 1,078,600 75,196 1999100 45,000 466,200 479,500 154,400 1,100,100 88,924 2000101 1,114,900 2001102 1,117,800 Note: Higher education enrollments are for full-time, day students only. Source: National Statistics Commission. 221. What do these enrollment figures imply about the coverage o f education programs? Clearly, coverage in pre-school education as a percentage o f the age group has declined sharply, whereas coverage in higher education has increased. For primary and secondary education, the evidence i s mixed. The government's official country report for the Educationfor All programg5reports a gross enrollment ratio for primary education o f 97.5 percent and a net enrollment ratio o f 97.1 percent for 1998, with virtually identical rates for boys and girls.86 These figures are the result o f official enrollment figures for primary education dividedby the government's estimate o f population for the normal primary education age group. '*CountryReporton Educationfor All, Bishkek 1999. 86The gross enrollment ratio expresses the number o f enrollments in a given stage of education divided by the estimated number o f children in the normal age group for that stage. The net enrollment ratio is the same ratio, except that the numerator includes only enrollments o f children within the normal age range for the education stage in question. Because the gross enrollment ratio includes overage children in the numerator but not inthe denominator, it overstates the actual coverage o f education. By excluding overage and underage children from the numerator, the net enrollment ratio attempts to correct for that error. 81 222. Household survey results on school attendance usually provide a valuable reality check on official enrollment figures. Inmost countries, survey data show rates of actual school attendance that are significantly below enrollment ratios which are based on official registration. InUzbekistan, for example, household survey responses imply rates of school attendance that are about 15 percentagepoints below the enrollment ratios that are calculated from official enrollment data.87 But inthe Kyrgyz Republic,the results of the KPrgyz Poverty Monitoring Surveys-which were carried out in 1996, 1997, and 19988 -lead to levels of school attendance for primary education that are very close to the net enrollment ratios inthe Educationfor All report. All these estimates are sensitive to the estimates of population that are adopted for the denominator of the calculation of enrollment ratios. The government's reported enrollment ratios are derived from registration data on enrollments and estimatedpopulation in the school-year age groups. Ifone calculates denominatorsinsteadfrom the single-year enumeratedpopulation aged 7 through 15 in the 1999 population census, it leads to a much lower gross enrollment ratio for grades 1 through 9 of 90.2 percent for the 1999/2000 school year. This finding i s much more consistent with the findings on basic education coverage from other countries in the region. It implies a total o f at least 200,000 children of compulsory school age that are not enrolled inschool. 223. The results of the 1999 census of population also provide a basis for calculating the regional pattern of school coverage. Table 6.3 presents gross enrollment ratios by oblast for primary and secondary education-grades 1through 11.89 The national gross enrollment ratio of 88.4 percent is surprisingly close to the 90.2 percent figure for grades 1through 9, implying little attrition inthe upper secondary cycle. What is particularly surprising is the low gross enrollment ratio o f 77.1 percent for Bishkek municipality and the high enrollment ratios for Batken and Naryn. These findings may reflect higher attrition to pursue employment opportunities inBishkek, and the absence of employment opportunities inBatken andNaryn Oblasts. Table 6.3: Grade 1-11GrossEnrollment Ratios by Oblast, 1999/2000 1999/2000enrollments, 1999 enumerated 1999 gross enrollment grades 1-11 - population, ratio age 7-17 years Bishkek 104,278 135,246 77.1 % Chui 158,298 183,842 86.1 % Naryn 66,700 71,901 92.8 % Issyk-Kul 98,286 110,589 88.9 % Talas 51,116 56,778 90.0 % Osh 301,733 332,170 90.8 % Jalal-Abad 221,7 12 248,094 89.4 % Batken 1011494 109;808 92.4 Yo Source: National StatisticsCommission. 87 "Uzbekistan: Living Standards Assessment," draff World Bank report, August 2002. Kyrgyz Republic: Poverty in the 1990s in the Kyrgyz Republic, World Bank report No. 21721-KG, June 2001. 89 Equivalent enrollment figures by oblast for grades 1through 9 are not currently available. 82 2. Education Quality 224. Although there are no time series data to track changing education quality, there i s a consensus on the part o f teachers, students, andparents that the quality o f education has deteriorated seriously over the past decade in all but a few well-endowed urban schools. Declining quality results mainly from the budgetary neglect which i s described below; it has led to depleted stocks o f textbooks and other educational materials, to an underpaid and demoralized teaching force, and to the physical deterioration o f schools. The increasingreliance on formal and informal parental contributions to meet essential school needs also results ina more unequal distribution o f educational quality. Large differences have emerged in teaching conditions and educational outcomes among oblasts and between urbanand rural schools. Ina recent national assessment o f fifth grade students, results in numeracy skills varied markedly by oblast and urbanlrural location. As shown inTable 6.4, four times as many studentsinBatken Oblast receivedassessmentscores in the lowest category as in Bishkek, and 70 percent more students in Bishkek received scores inthe highest category than inBatken Obla~t.~'Similar but smaller differences in assessment results were recorded between rural and urban schools across oblasts. Table 6.4: Fifth-Grade Assessment Resultsin Numeracy by Oblast, November 2000 YOreceivinglowest category YOreceiving scores highest categoryscores Bishkek 10.2 32.1 Chui 17.0 23.3 Naryn 11.6 33.8 ISS~k-Kd 21.1 33.3 Talas 26.5 27.6 Osh 20.3 29.6 Jalal-Abad 14.8 27.4 Batken 41.2 18.9 Source: Monitoring Learning Achievement: National Survey of Primary Education Quality, Bishkek, 2001. 3. Education Efficiency 225. Table 6.5 presents figures on average school size, class size, and studendteacher ratio by oblast for 1997. The smaller size o f rural schools and rural school classes reflects the greater dispersion o f population inrural areas. The ruralhban differences in school size and class size are less than expected, reflecting the growth o f rural schools as a result ofpopulation growth, andthe relatively modest rural-urban migration rates. 90Monitoring Learning Achievement, Bishkek, 2001. 83 Table 6.5: Deploymentof Schoolsand Teachers by Oblast, 1997 Schools Students Teachers Classes Schoolsize Class size S-T ratio rural schools Kyrgyz Republic 1,597 761,634 50,902 32,147 476.92 23.69 14.96 Jalal-Abad 372 179,580 11,397 7,465 482.74 24.06 15.76 Issyk-Kul 133 58,445 4,304 2,581 439.44 22.64 13.58 Naryn 97 44,449 3,456 1,889 458.24 23.53 12.86 Osh 623 305,816 21,020 12,628 490.88 24.22 14.55 Talas 98 42,265 3,114 1,970 43 1.28 21.45 13.57 Chui 274 131,079 7,611 5,614 478.39 23.35 17.22 urban schools Kyrgyz Republic 377 291,745 16,242 10,850 773.86 26.89 17.96 Jalal-Abad 45 32,598 1,723 1,249 724.40 26.10 18.92 Issyk-Kul 57 35,558 2,107 1,351 623.82 26.32 16.88 Naryn 42 20,444 1,511 830 486.76 24.63 13.53 Osh 74 73,717 3,886 2,631 996.18 28.02 18.97 Talas 10 7,871 430 271 787.10 29.04 18.30 Chui 42 22,419 1,195 903 533.79 24.83 18.76 Bishkek 107 99,138 5,390 3,615 926.52 27.42 18.39 Source: Jan Herczynski, "Key Issues of Governanceand Finance of Kyrgyz Education," draft report, 2002. 226. Intensity of teacher use by oblast varies more significantly in terms of teaching load (TL), teachers per class (TC), and teaching hours per class (HC), as shown inTable 6.6. The significantly lower number of teachers per class and higher teaching load for Chui Oblast, for example, indicates a higher intensity of teacher use, which, if emulated inthe other oblasts, would leadto significant budgetary savings. The scope for achieving such savings i s discussed later inthis chapter. Table 6.6: Intensity of Teacher Use by Oblast, 1997 Rural Schools Urban Schools TL TC HC TL TC HC Kyrgyz Republic 19.18 1.58 30.36 22.13 1.50 33.12 Jalal-Abad 19.70 1.53 30.07 23.33 1.38 32.18 Issyk-Kul 18.36 1.67 30.61 20.31 1.56 31.68 Naryn 16.69 1.83 30.54 17.41 1.82 31.70 Osh 18.32 1.66 30.49 22.09 1.48 32.62 Talas 19.17 1.58 30.31 21.58 1.59 34.25 Chui 22.37 1.36 30.32 24.08 1.32 31.86 Bishkek 23.42 1.49 34.91 Source: Herczynski, op. cit. 84 D. MANAGEMENT ANDFINANCINGOFEDUCATION 227. The management o f public education institutions varies by level and type o f institution. Most pre-schools are managed by the Ministry o f Education and Culture (MEC), although there are a few surviving pre-schools managed by other ministries." Most primary and secondary general education schools are intended to be managed by local governments. But local governments' actual management discretion for these schools i s very limited because the MEC, through its rayon-level Departments o f Education, appoints principals and teachers, and because the republican budget finances teacher salaries (these financing arrangements are described below). The M E C directly manages a small number of boarding schools for orphans, handicapped students, and other students with special needs. Operation o f these schools i s financed by the republican budget. Principals in these schools are appointed by the Minister o f Education; teachers are recruited by the principals. The Ministry o f Labor and Social Protection (MOLSP) manages the national network o f professional technical schools (PTUs). The PTUs are vocational schools that offer skilled worker qualifications. They were formerly attached to and financed by public enterprises, and were transferred to the M E C early in the transition when public enterprises came under severe financial pressures. The MEC and the relevant technical ministries also manage special secondary schools (or technicums). Technicums offer higher-level training for master craftsmen. Most o f the students in the PTUs and technicums are financed by the republican budget, but a growing percentage of students-currently, about 25 percent o f enrollments-are contract students and pay fees which range from 7,000 to 14,000 som per year.92Public universities are also managed by the M E C and combine both budget-financed and fee- financed students. Only one-third (or 32,340) o f the 64,941 full-time public university students are budgetfinanced.93 The rest are contract students who pay fees ranging from 3,000 to 60,000 som per year. 228. The decline innationaloutput andrevenue since the start o fthe transition is by far the most important factor affecting the financing o f education in the Kyrgyz Republic during the past decade. The second most important factor has been the government's evolving decentralization policy. Under this policy, local governments were initially given responsibility for managing and financing all costs o f primary schools and general secondary schools, regardless o f the adequacy o f local government revenues. Duringthe first two years that this policy was applied, it had disastrous effects on education programs. Inall but the most affluent communities, schools lacked teaching materials o f all kinds, as well as heating and utilities; teachers were either not paid at all or were paid only after long delays. Most schools continued to function, and enrollments increased. Butthe number o fteachers declined and the conditions for teaching and learning inmost schools deteriorated markedly. " Over 1,000 ofthese pre-schools formerly managedby other ministries, and often attachedto public enterprises, haveclosedsince the start ofthe transition. 92Key Issues of Governance and Finance of Kyrgyz Education, draft report by Jan Herczynski, 2002. 93The proportion of contract students has increasedin recent years. For the incoming class for 199912000 the proportion was 19.7 percent. 85 229. To respond to this problem, the government in 1997 introduced categorical grants to oblasts, which were specifically designed to meet the essential costs o f education and health services at the local level. The government initially intended that these grants would finance education and health services on a capitation basis. This would allow local governments the flexibility to decide how to provide these services in the most efficient manner. For education, the basic per student grant was to be multipliedby an age-related coefficient that was designed to capture the higher costs o f providing education at higher levels.94 But it quickly became apparent that strict application of the capitation formula would lead to mass layoffs o f teachers in some oblasts. For that reason, the categorical grants were distributed to oblasts with instructions to give priority to paying teacher salaries and benefits. Similar guidance was provided for the use o f the health portion o f the grant. The grants were reduced for Bishkek municipality and for those oblasts with significant revenues from local taxes. 230. InJanuary 2001, Parliament adopted a newLaw on Teacher Status which requires that teacher salaries and benefits for public primary and secondary education be financed fully and on time by the republicanbudget. Although the Law on Teacher Status does not specifically amend the 1998 law that established the categorical grants, it effectively supersedes that legislation. Transfers are now being providedto oblasts with instructions to use them fully to meet the cost o fteacher salaries and benefits. 231. The government also initially intended to finance centrally managed education programs on a differentiated capitation basis. But here, too, the actual allocation process has reverted to financing inputs, with priority given to teacher salaries, electricity and water, student stipends, and meals in boarding schools. Other essential inputs into the teaching and learning process, including textbooks and teachers' manuals, are either financed by parents or, when parents cannot afford it, are not provided at all. In communities where local governments and parents cannot afford to finance textbooks and other essential teaching inputs, the quality o f primary and secondary education has fallen to unacceptably low levels. This includes most rural primary and secondary schools, which are often in very poor condition and lack heating, and where many children lack textbooks because their parents cannot afford even the modest cost o f renting them. (Textbook rental costs are 10 som or 30 cents per textbook in the initial grades, and 15 som or 45 cents each inthe upper grades). This lack o f textbooks i s particularly frequent above the second or third grade, because families which have difficulty in affording rental textbooks generally give priority to providing textbooks inthe lowest grades. 232. Under an April 2002 Presidential Decree, budget financing for higher education studentsis to be provided on a capitation basis starting inSeptember 2002. The MoF has prepared a schedule of per student allocations for this purpose. Allocations vary by specialization, and average 5,000 som per student annually. 94Under this scheme, local governments would receive the normal allocation for each student aged 7 to 13. This allocation would be multiplied by a coefficient of 1.2 for each student aged 14 or 15, a coefficient o f 2.3 for each student aged 16 or 17, and a coefficient o f 2.0 for each student in boarding schools. Additional coefficients were to be developed for students in mountainous and rural areas to reflect the higher costs o f providing education inthese areas (Herczyhski, op. cit.). 86 E. CONCLUSIONAND FUTURE AGENDA 1. The Durationof SecondaryEducation 233. The current 11-year system inthe Kyrgyz Republic has evolved from the former Soviet system in which all students were required to complete 8 years o f primary education and two years o f either general secondary education or vocational/technical education. After these 10 years o f compulsory education, students could enter university. After the dissolution of the Soviet Union, Russia extended the duration of primary education from 8 years to 9 years, which raised the coverage o f secondary education to grades 10 and 11. In 1994, the Kyrgyz Republic did the same. This extension o f secondary education from 10 years to 11 years inthe Kyrgyz Republic was carried out by fiat, Because the extension was not accompanied by the development o f a new, 11-year curriculum and the necessary reprogramming o f teacher training and facilities, the system effectively remains a 10-year system. Virtually all students progress directly from grade three to grade five, without interruption inteaching and learning content. 234. InMay 2002, the government approved a proposal to further extend secondary education to 12 years by 2010, in line with the practice in most OECD countries. This change could yield important benefits for the Kyrgyz economy and society, and should be implemented as soon as effective implementation i s feasible. But there are serious questions regarding the feasibility and sustainability o f this proposal. Evenwithout this further extension o f secondary education, there are many unmetrequirements for the real implementation o f the current 11-year system. This includes developing new curricula and teaching materials, training teachers, and reprogramming and extending existing school facilities. Full implementation o f the existing 11-year secondary policy would require years o f preparation as well as a serious commitment interms o f investment and recurrent budget resources. 235. Because o f the very large fixed costs involved in any reconfiguration o f the education system, it would be best to make one change and to fully absorb it before further changes inthe structure of education are contemplated. Itwould be prohibitively disruptive and costly to implement the 11-year systemand then immediately progress to a 12-year system. For this reason, it is recommendedthat afeasibility study be carried out to examine the educational, financial, and implementation requirements of the 11-year and 12-year options for secondary education. Only if it can be demonstrated that the educational, financial, and other requirements can be provided should either of these options bepursued. 2. Education Governance 236. Under the government's decentralization policy, most secondary schools are meant to be managed and financed by local governments. The level at which local management takes place varies, dependingon the capacities at the oblast, rayon, and local levels. Inreality, local governments exercise little control over their secondary schools. Local governments' discretion to manage education resources-including the discretion 87 to consolidate schools and reduce staffing-is fundamentally circumscribed by centrally mandated norms. These norms specify, for each level and type o f course, the minimum and maximum permissible class sizes and the minimum and maximum number of teaching hours per teacher. Local governments' discretion i s also circumscribed by the fact that teachers and school principals in "locally managed" primary and secondary schools are appointed by rayon education departments rather than by local governments themselves. There is thus a fundamental disconnection between local governments' responsibilities for deliveringsecondary education and their means for doing so. 237. These centrally imposed constraints are intended to ensure that locally managed secondary education meets national standards for quality and content. But they are not an effective instrument for providing quality assurance for education. A far more effective approach to quality assurance would be for the rayon and oblast education departments to evaluate teaching practices at the school level by observing whether teaching practices are consistent with the approved curriculum and whether they reflect the changes in pedagogy which are intended under the education reform program. These changes include a more student-centered, inquiry-based approach, and an emphasis on the synthesis and application of knowledge rather than the mere accumulation o f factual knowledge. Inthe medium term, educational evaluation shouldreflect educational value added in terms o f changes in learning achievement at the school level as measured through student assessment. Student assessment i s currently being introduced in the Kyrgyz Republic, but i s not yet well enough established to serve as a basis for evaluating teaching effectiveness. 238. To address these governance issues, it is recommended that the roles of central and local authorities be changed in order to align responsibilities and accountabilities for managing primary and secondary education. In general, this would mean empowering local councils to manage schools effectively-including hiring school principals and teachers, and carrying out actions such as staff reduction and school consolidation that are necessaryfor improved efficiency. Quality assurance should be provided by the MEC and its oblast and rayon education departments through observing and assessing actual teaching practices and classroom results, rather than through managing teacher recruitment and assignment and controlling class sizes and teaching loads. This would require the preparation andpromulgation of the enabling legislation and decrees, the dissemination of the plan, and the development of capacities at the central and local levels to discharge these new roles. Student assessment should continue to be developed as an eventual basisfor quality assurance and the evaluation of school performance in terms of value added in learning. 3. EducationFinance 239. There are distinct issues ineducation finance which relate to: the overall level o f public support for education; teachers' salaries; the level at which education services are provided; the formula for apportioning budget funds to specific education institutions and uses; and the mixture o f public and private financing in public higher education. The issues and recommendations for these topics are summarized inthe discussionbelow. 88 240. Level of Public Support. As shown in Table 6.7, the share of consolidated public budget allocated to the education sector was essentially the same (20 percent) in 2000 as in 1990, and increased to 23 percent inthe 2001 budget year. But inspite of this increased level o f commitment, the share o f GDP devoted to education fell by exactly half during the 1990s-from 7.4 percent in 1990 to 3.7 percent in 2000. This decline reflects the smaller size o f the public sector under the market economy. As shown in Table 6.8, this i s a lower share o f GDP spending on education than in other countries in the region with the exception of Russia and Tajikistan; it is considerably below the average for the OECD. Expressedin real terms, public expenditures on education have fallen even more sharply-to just one-third of their 1990 level, reflecting the combined effect of the smaller public sector and the sharp decline inGDP. Table 6.7: Public Expendituresfor Educationas a Share of TotalPublic Expenditures,1990-2001 Education Education Total Public Education as GDP Education Expenditures Expenditures Expenditures % of Total (inmillions as YOof (in millions of (inmillions of (inmillions of Public of current GDP current som) 1995 som) current som) Expenditures som) 1990 3.2 2,381.0 15.9 20.1 % 43 7.4 % 1991 5.6 1,775.5 24.4 23.0 Yo 93 6.0 Yo 1992 37.3 1,271.4 231.1 16.1% 741 5.0 Yo 1993 227.2 906.3 1,225.8 18.5 % 5,355 4.2 Yo 1994 730.8 1,038.0 2,812.8 26.0 Yo 12,019 6.1 Yo 1995 1,064.9 1,064.9 4,610.5 23.1 % 16,145 6.6 % 1996 1,222.8 903.5 5,202.4 23.5 % 23,399 5.2 Yo 1997 1,514.0 937.6 6,695.7 22.6 Yo 30,686 4.9 Yo 1998 1,681.6 954.7 7,298.3 23.0 % 34,181 4.9 % 1999 1,892.3 780.9 9,042.2 20.9 Yo 48,744 3.9 Yo 2000 2,289.9 740.17 11,284.5 20.3 Yo 62,203 3.7 Yo 2001 2,849.3 854.3 12,257.0 23.2 % 73,890 3.9 % Sources: National Statistical Committee and World Bank database. Table 6.8: Public Expenditureson Education,KyrgyzRepublic and Selected Comparator Countries, 1997 Country Public Expenditureson Educationas YOof GDP Belarus 5.6 % CzechRepublic 4.2 Yo Denmark 8.2 Yo Estonia 6.8 % Finland 7.5 Yo France 5.9 Yo Germany 4.6 Yo Hungary 4.6 Yo Kazakhstan 4.4 Yo Kyrgyzstan 3.9 Yo Latvia 6.8 Yo Lithuania 6.4 Yo Russia 3.5 Yo Tajikistan 2.2 % Uzbekistan 7.7 Yo Note: Expenditure figures are for the most recent year reported. Source: World Bank database. 89 241. Effects of Budgetary Contraction. What effect has this budgetary contraction had on educationprograms? Among the most serious effects are the following: 0 Widespread deprivation o f the basic educational materials needed for effective teaching and learning and for the modernization o f education programs. The recent National Survey o f Primary Education Quality found, for example, that 80 percent o f primary schools lacked a complete supply o f textbooks for students, 70 percent lacked teachers' guides, 20 percent lacked desks and chairs for students, 70 percent needed repairs to school furniture, 23 percent lacked a water supply, and 39 percent lacked telephone^.^^ 0 A serious decline in teachers' salaries, which has eroded teacher morale and motivation, has induced many teachers to take additional jobs, and has exacerbated the problems o f corruption, 0 Increasing inequality in the quality o f education and access to education, as the shrinkage o f central budget support has led to increasing reliance on unevenly available local financing, parental contributions, tutoring, supplementary financing through the rental of premises, and non-educational activities. On average, 35 percent o f the expenditures o f primary schools inurban areas and 25 percent of expenditures of rural schools come from non-budget sources (Table 6.9). The increasing reliance on these non-budgetary sources i s not only a source o f increased inequality but also threatens to displace the core teaching function o f primary and secondary schools. 0 The cessation o f new school construction, which has led to excessively intensive use o f existing school facilities. Only 10 percent o f primary schools operate on a single shift. Fully 81 percent o f rural schools and 71 percent o f urban schools operate on double shifts. Nine ercent o f rural schools and 19 percent o f urban schools operate on triple shifts. 98 0 The development ofparental contributions as an important source of financing for school maintenance, fuel, and other necessities in urban schools. Parental contributions to urban schools often exceed US$100 per year per student. Parents also contribute to schools in rural areas, but widespread poverty means that income from this source i s very limited. The reliance on parental contributions is a major source of inequity inthe quality o f education. 0 The re-emergence o f arrears inteachers' salaries. The Ministryo f Education and Culture reports that payment o f teachers' salaries i s inarrears inthe amount of 43 million som (about US$930,000) as of September 2002.97 95Monitoring Learning Achievement, Bishkek, 2001. 96Monitoring Learning Achievement, Bishkek, 2001. 97Kyrgyz News, September 2,2002. 90 Table 6.9: Sources of Financing for Primary School Expenditures Urban Schools Rural Schools Government budget 65 Yo 75 Yo (Republican + local) Tutoring 19 Yo 2 Yo Parents' fees 13 % 7 % NGO contributions 2 Yo 8 % Private sponsors 1 Yo 6 % Income-earningactivities 0 % 2 Yo Source: Monitoring LearningAchievement, Bishkek, 2001. 242. To address these issues and to support the development of the Kyrgyz Republic's most important economic resources-its human resources-it is proposed that the government devote 4percent of GDP to education in the 2003 budget and increase that share in subsequent years in order to reach the government's target of 6 percent in 2005.98 4. Low Teacher Salaries 243. Teacher salaries-which averaged 857 som per month in 2001-are low in both absolute and relative terms. In absolute terms, they are only half the minimum consumption level for individuals, not to mention households. As a result, teachers lack motivation, and are compelled to work at other jobs in order to support themselves and their families. In higher education, low faculty salaries have contributed to a serious problem of corruption, with students often paying for admission and grades. This has led to a serious deterioration in the quality of education. More significantly, it has led to cynicism on the part of employers and the public regarding the significance of higher education diplomas, except for the few institutions that have been able to prevent or control corruption. 244. Teacher salaries are also low ina relative sense, as shown inTable 6.10. Average monthly earnings inthe education sector arejust 857 som, versus the considerably higher average earnings in all other sectors except forestry and health. It is notable, in particular, that average teacher salaries are less than 40 percent of average earnings in public administration. 98In an address to the Annual Conference of Schoolteachers in Bishkek on August 27, 2002, President Akaev announced the government's plan to allocate 6 percent o f GDP to the education sector by 2005. 91 Table 6.10: Average Monthly Earnings in 2001 by Sector (incurrentsom) Sector Average Monthly Earnings Health 710 Education 857 Industry 2,466 Transport 1,684 Communication 3,030 Construction 1,894 Trade 936 Finance 4,650 Public administration 2,159 Forestry 556 Source: National Statistical Committee. 245. Under the reforms which are beingpiloted inthe health sector, the introduction o f copayments and health insurance payments, accompanied by a sharp reduction in staffing, have led to major efficiency gains and significantly higher earnings for physicians and other health staff.99 They have also sharply reduced corruption as under- the-table payments for health services have beenreplacedby the more transparent system o f copayments. Teachers do not have equivalent opportunities to supplement their income (although some activities, such as mentoring new teachers, or providing community education or remedial education, might be compensated through supplementary income). Moreover, whereas copayments are desirable in the health sector to discourage excessive use o f health services, they are not desirable in the education sector at the compulsory education level, where fuller use o f education is to be encouraged, not discouraged. Although class sizes in urban schools are relatively large by OECD standards, there are opportunities in some cases to release resources that might help finance increased teacher salaries. A more widely applicable approach to mobilize savings to help finance improved teacher salaries i s to raise required teaching hours, which are very low by international standards. It would be easier to implementa plan to improve teacher salaries inexchange for more intensive use o f teachers if it is undertakenon a voluntary basis by individual rayons or oblasts. 246. The goal o f increasingteacher salaries would be more feasible if some o f the cost o f this measure were to come from efficiency improvements within the sector. There i s considerable room for seeking more intensive use o f teachers in exchange for higher salaries. The required teaching hours in the Kyrgyz Republic are low by Western standards, as shown in Table 6.11. Teachers in primary and secondary schools are requiredto teach 18 50-minute class periods per week. This is reducedfrom the 22 to 24 hours per week that were required during the Soviet period. The required number o f teaching hours defines a standard teaching load, or "norm". Teachers are paid for teaching hours above the norm, up to 2 norms per teacher. Teaching more than the minimumteaching load is a widespread practice. Nationwide, the average teaching load in primary and secondary education is 1.4 norms. The opportunities for teachers to supplement their teaching income are unevenly distributed. There i s generally more 99 These improvements have been undermined duringthe 2002 budget year because the MoF has reduced central financing by the amount o f the efficiency savings, thereby removing the incentive for health sector staffto maintain the reforms. 92 opportunity to be paid for additional teaching hours, and to have additional income from tutoring or other paid employment, in larger, urban schools than in rural schools. At the same time, the cost o f living i s lower in rural areas, and rural teachers often have small farms that provide either cash or in-kind income. Teachers who have met the requirements for a retirement pension can continue to teach and receive their full pension. Table 6.11: Teaching-HourRequirementsin Primary Education,Kyrgyz Republicand SelectedComparator Countries RequiredTeaching Periods Country Per Week France 27 Portugal 25 Belgium 23.3 Turkey 20 KyrgyzRepublic 18 NewZealand 25 UnitedStates 33 Source:Education at a Glance,2001, OECD. The figure for France includesnon-teachingtime for consultation. 247. To address the issue of inadequate teacher salaries, it is recommended that the government develop and subsequently implement the necessary legislation and decrees to encourage rayons to achieve savings in teacher deployment through higher required teaching hours and reduced numbers of teachers and, wherepossible, increased average class sizes in conformity with international standards. To increase the incentivefor local governments and teachers to pursue such eficiency gains, local governments should be allowed to keep the savings from these measures for other educational improvements, and should be permitted to use part of the savings to increase teacher salaries in exchangefor higher minimum teaching hours. 5. Centralor Local Financing? 248. Economic theory predicts that reliance on local financing for services that provide widespread benefits (or "externalities") will lead to lower levels o f financing and provision than reliance on central financing. Education expenditures are widely recognized as generating widespread indirect benefits for society, beyond the direct benefits that accrue to the individuals who are educated. This i s particularly true o f initial education. Relying on local governments to finance primary and secondary education in any setting risks underspending on education, or providing a lower level of education than the economically efficient allocation. This i s a predictable outcome o f decentralizing financing responsibility for pre-university education; it is, broadly, what happened in the Kyrgyz Republic after decentralization. Although education expenditures as a percentage of total public expenditures did not decline significantly after decentralization, they did decline quite sharply as a percentage o f GDP and in real terms (Table 6.7). The proportion o f GDP devoted to education in the Kyrgyz Republic (3.9 percent) i s among the lowest in the region (Table 6.8). The low level of education expenditures may undermine the country's efforts to raise productivity and growth performance in the 93 future. Decentralizationto date has made this situation worse, not better. The changes in the financing formula that are outlined below would help to address this problem. In carrying out improvements to the financing formula, a key principle i s that the central budget should finance the bulk o feducation costs-at least at the basic education level. 6. The FinancingFormulafor Education 249. In principle, local governments manage primary and secondary schools and finance them from their own resources. Orphanages, boarding schools, specialized secondary schools, and higher education are managed by the MEC and financed under the republican budget. Application o f this policy in 1995 and 1996 led to serious problems in the delivery o f education and also to serious problems o f arrears and non- payment o f teacher salaries. In response, the government recentralized the financing o f teacher salaries for primary and secondary education. Until last year, the mechanism for the central funding o f teacher salaries was a categorical grant to each oblast-one intended to ensure a minimum acceptable level of health services and primary and secondary education. The education portion o f this financing was intendedto be provided on a per student basis, but in reality it was based on historical teacher salaries and benefits ineach oblast. 250. As shown in Table 6.12, education now accounts for almost half of total expenditures o f local governments. The categorical grant is a lump sum, which i s intended to fully cover salaries o f teachers and health workers in each oblast. In principle, oblasts are free to spend the categorical grant as they see fit, but the amounts provided are needed for salaries o f existing staff inthe education and health sectors; the funds are usually treated as non-discretionary by both local governments and central authorities. There i s little scope or incentive under this arrangement for local governments to seek economies through a more intensive use of staff or a reconfiguration o f schools because maximum class sizes and teaching loads are set by the MEC, and because local governments perceive that the MoF would reduce their budgetto offset any savings which they might achieve by reducing the number of health or education staff. Table 6.12: Education Budgets by Source, 1999 and 2000 (inmillions ofcurrent som) Republican Budget LocalBudget Total State Budget 1999 Education 538,839 1,353,445 1,892,284 Total 7,68 1,23 1 2,809,423 9,042,143 Education as YOof total 7.0 Yo 48.2 Yo 20.9 % 2000 Education 736,801 1,553,119 2,289,920 Total 9,740,761 3,407,398 11,284,500 Educationas YOof total 7.6 % 45.6 % 20.3 Yo Source: Dataprovided by MoF. 251. The role of the categorical grants for education changed somewhat under the new Law on Teacher Status that was adopted by Parliament inJanuary 2001, This legislation requires the republican budget to finance all teachers' salaries in primary and secondary education. As a result o f this legislation, rayon governments are tending to use the 94 categorical grant first to meet education salary requirements, and only then for health staff salaries. Where the amount o f the categorical grants i s insufficient to finance all education and health salaries, priority i s given to education. 252. The current practice o f financing teacher salaries under the republican budgethas the compelling advantage o f ensuring that even the poorest localities are able to pay teachers' salaries and keep their schools open. But it also has two serious disadvantages: (i)it does not provide scope or incentive for improved efficiency through the redeployment of teachers and the consolidation o f schools; and (ii) does not include it financing for textbooks and other essential inputs to effective education. Textbooks are financed by parents under a textbook rental scheme. Although rental charges appear modest in an absolute sense, as has beenmentioned, the extremely low level o f incomes means that many households cannot afford the cost o f textbook rental. This i s a major reason for the low quality o f education and for incomplete school attendance in poor areas-including many rural areas. More fundamentally, the practice o f financing teacher salary costs under the republican budgettreats existing teacher costs as non-discretionary and hence tends to legitimate what may be an inefficient delivery o f education. 253. A preferred basis for the central financing of education costs is through a differentiated capitation system o f financing, which pays providers for education on the basis o f the number of students enrolled ineach type o f program. Underthis approach, it i s important that the financing formula reflect intrinsic sources o f higher costs-such as dispersed population, and a higher-than-average density o f students with special learning needs. But developing such a formula will require a careful examination o f the sources and magnitude o f intrinsic cost differences prior to the implementation o f the formula. Another problem i s that the current financing formula provides virtually no financing for in-service teacher training. Failure to fund teacher training i s a high-risk and low- efficiency option, because it means that the education system's most important asset-its teachers-are not equipped to perform their work effectively, especially in introducing the important innovations planned under the education reform. The financing formula should also include a provision for heating and other utilities, which account for an unusually large share o frecurrent costs. 254. In the short term, it is recommended that primary and secondary education textbooks and utilities, as well as teacher salaries, be financed under the republican budget in order to provide more equal learning opportunities to all children. In the medium term, to improve the efficiency o f education delivery, it i s recommended that education financing for all levels o f education move from an input-based formula to an output-based (students and educational results) formula. This output-based formula should be differentiated to reflect the intrinsic cost differences for different subject areas, different levels o f education, and different parts o f the country (reflecting, for example, the higher cost o f providing education of adequate quality in areas with highly dispersed population, difficult access, and particularly severe weather conditions). As a basis for developing an objective, cost-differentiated capitation formula for education, it is recommended that the government carry out a study o f factors affecting the costs o f the efficient delivery o f education for primary, secondary, and higher education. 95 255. The 2001 Law on Teacher Status requires that teacher salary costs be fully fimded by the republican budget. By not taking local revenue capacity into account, this legislation unnecessarily inflates budget costs. It is recommended that the republican budget grants to local governmentsfor education be reducedfor oblasts with signi$cant own revenues that could be used tojnance aportion of education costs. 7. Higher EducationFinance 256. There are 43 higher education institutions inthe Kyrgyz Republic. Inthe absence o f any effective quality control, education varies widely in quality. Corruption i s a problem at all levels of the education system-particularly in higher education, where informal payments often secure university admission or a good examination grade. As a result, diplomas are suspect except in the few universities that have strict controls on corruption. Public funding for higher education used to be based largely on historical costs, with negotiation of the final budgets provided. Starting in September 2002, financing is to be provided on a per student basis, with average per student allocations averaging 5,000 som per year. Within public higher education, there is a system of "contract education" which is equivalent to private universities operating within ostensibly public universities. Currently, about 75 percent of students in public higher education institutions are "contract students" and pay fees ranging from 3,000 to 60,000 som per year, and averaging about 10,000 som per year. Budgetary funding of higher education students is limitedto "budget students" who score above a designatedthreshold on the university entrance examination. The number of budget places for students in higher education i s set by the National Anti-Monopoly Commission and is based on the judgment of national needs in each area. Budget students are particularly numerous in fields such as agricultural and industrial engineering, which were developed and promoted to meet the needs of the planned economy under the former system. Contract students are heavily concentrated in fields such as management, economics, and the humanitiesthat have grown rapidly inrecent years to meet the needs of the new market economy. 257. The fees paid by contract students are much higher than the average per student budget of 5,000 som per year (US$lOO) provided by the MoF for higher education institutions."' Contract students tend to be of lower ability because of the lower examination performance requirement for entrance.lo'In spite of this fact, university faculty often prefer to teach in classes for contract students because this offers salary supplements from the contract student fees. University faculty inthe public universities earn about 2,000 som per monthunder the unifiedsalary scale. But the average earnings of university faculty are actually about 5,000 som per month, because o f supplements financed by contract studentsandmultipleteaching assignmentsheldby many faculty. looLSMS 1998 reportedhigher educationtuition payments of 2,402 som per year, averagedover all students (contract and budget students in public higher education,plus private higher education). The 2001 householdbudget survey reported average higher education contract fee paymentso f4,673 som per year. lo'But there are reportsthat some budget students are actually of lower ability but obtained their budget positions through corruption, rather than by scoring above the threshold score on the national examination. 96 258. The current system of financing most public higher education through a combination o f budget finance and fee payment by lower-performance students inpublic universities i s highly inequitable and blurs the distinction between the public and private sectors. It also effectively relies on segregated, private programs within ostensibly public universities to meet student demands for the new subjects which are particularly important to the country's future; it uses public, budget financing to support traditional courses which are less in demand by students. The system suffers from corruption at entry, corruption within the system, and regressive incidence, since students from poor households are least likely to have attended high-quality secondary schools and to have scored highly enough on the university entrance examination to qualify for budget- subsidized positions. The system i s inefficient because it encourages the most capable faculty to concentrate on teaching the least capable students (where they receive salary supplements from retained fees). It also consumes a disproportionate share of public resources for education inrelation to the compulsory cycle (Table 6.13). There i s a need for greater selectivity in the public financing o f higher education in order to free some resources to reallocate them to compulsory education, and also to limit public financing to centers o f excellence which can serve as a model for privately financed higher education institutions. There i s also an urgent need to reduce corruption in higher education through the application o f more objective entry criteria and strict sanctions on corruption within higher education. Table 6.13: ConsolidatedEducationExpenditures(Republican Budget Local) and Per Student + Expendituresby Levelof Education, 1998 Pre-school Secondary Higher Public expenditures 109.3 1,079.0 322.9 (millionsbfsom) Enrollments(public) 46,100 1,13 1,100 121,000 Per student expenditures 2,370.9 954.0 2,668.6 (current som) Source: NationalStatistical Committee. 259. To address these issues, it i s recommended that the government use public financing in higher education much more selectively by essentially pursuinga policy o f triage as a deliberate instrumentto improve the quality o f higher education. Ultimately, this could take the form of student vouchers for the most capable students. But inthe short term it would be more effective to limit public support to the few institutions that genuinely have the potential to be centers o f excellence and to let the other higher education institutions fend for themselves. The practice o f designating which specific fields o f study should receive budget support should be replaced with a system that encourages educational excellence in all fields. These changes in financing should also be accompanied by measures to develop: (i) an objective, examination-based process for university admission; (ii)an independent accreditation body for higher education institutions and programs; and (iii) trustee management for higher education institutions as an instrument for developing a broader base of accountability. 97 7, SOCIAL PROTECTION A. INTRODUCTIONAND BACKGROUND 260. This chapter highlights several key messages. First, Kyrgyz social circumstances are bleak. Despite a falling poverty rate in the last two years, the poverty rate remains at more than 40 percent and was substantially higher inprevious years. It i s clear that social protection programs cannot offset a sustained economic slump, which undercuts the revenue base for programs while swelling the need for assistance. Sustained economic growth i s therefore central to any effective future social protection strategy. 261. Second, because pensions dominate programmatic social protection spending, key policy and expenditure issues for pensions are critical for social protection as a whole. One such issue i s whether the Government will retain the pension objectives o f the 1997 reforms and will thus accept the relatively low levels o f income adequacy and earnings replacement that the system can currently generate. Ifnot, the Government will need to sharpen its priorities among competing pension objectives. In that case, it should seriously consider giving priority to income adequacy over earnings replacement. It should, for a limited number o f years, pursue the operational objective o f raising the level o f all age pensions to at least the severe poverty line through a "topping-up" approach to pension increases, inplace o f across-the-board indexation. 262. A further urgent issue, given the Social Fund's continuing history o f diverting health insurance contributions to fund pensions, i s how to achieve reliable and full funding for the Mandatory Health Insurance Fund, thereby preserving the availability o f health services and the process o f health-sector reform. 263. Another key question is whether to pursuethe Government's expressedinterest in moving to a funded approach to pensions by first investigating the prerequisites, costs, and feasibility o f this approach in current Kyrgyz circumstances, before taking any irrevocable steps to create and implement a funded system. A separate pair of questions i s how to maintain an adequate level o f spending on social assistance programs and how best to coordinate and rationalize the current set o f programs so as to target these expenditures more effectively to the poorest households. 1. Social Protection Programs and Their Evolution 264. Pensions. In 1992, the Kyrgyz Republic inherited a pension system covering almost everyone and paying relatively high benefits. These were often above the minimum consumption basket (MCB), and well above the poverty line.102 After independence, the economy sank into a deep recession, fiscal resources vanished, and Io* Although revised in 1995, the MCB level is well above the general poverty line. It was 1.8 times the levelofthe poverty line that resultedfrom analysis ofthe LivingStandards MeasurementSurvey. 98 benefits plunged. Average benefits in 1994 were only 40 percent of the MCB, or 70 percent of the general poverty line. With restructuring of enterprises and downsizing in government employment, pressure to increase pensions materialized in full after the economy began to recover in 1996. Pension expenditures exploded from 4.3 percent of GDP in 1994to 6.9 percent in 1996, creating a financing gap emerged equivalent to 1.7 percent of GDP. 265. The Kyrgyz authorities reactedto the urgent needto control pensionexpenditures by eliminating most privilegedpension categoriesin 1996, applying a new Pensionlaw in June 1997, and further compressing the benefit distribution. Additional short-term adjustment measures (i-e., freezing benefits and skipping one month) were taken in 1998, as well as the decision to increase retirement ages gradually. The reforms were intended to create a structured and fiscally sustainable pension system that, in its initial years, would deliver quite modest pensions. Over the long term, however, it would mature into a balanced and more adequate system. The mature system would deliver minimum pension levels exceeding the poverty line-but this would take several years to achieve. It would also offer rates of replacement of pre-retirementearnings averaging 40 percent at the time of retirement. 266. These policies have succeeded in significantly reducing the overall size of the system from 6.1 percent of GDP in 1997 back to 4.1 percent of GDP in 2001. They showed, however, that the system currently cannot finance average pension benefits higher than 40 percent of the minimumconsumption basket (about 10 dollars per month). The spread between the lowest and the highest pension, however, grew somewhat as a result of ad hoc indexation policies but also because the new system began to weight more previous contributions-albeit gradually. 267. Currently, pensions still dominate social protection spending. Consequently, their structure i s important for discussions of expenditure policy. The current pension system operates under the State Pension Law of October 1997, as amended inJune 1998. It is a pay-as-you-go system that provides old-age, disability, and survivor pensions. It also provides health coverage, burial allowances, and certain additional payments to special categories of pensioners. Old-age pensions are paid to any person with at least 5 years of insurance who has reached the standard retirement age. This is currently rising by 4 months every year until it reaches 63 for men and 58 for women in 2006. Retirement is available up to 5 years early for certain groups and upto 10years early for others. 268. Pensionbenefits are calculated as the sum of three components: a base pension, a component reflecting work prior to 1996, and a component reflecting insuredwork since January 1, 1996. The base pension was initially set equal to the minimumbenefitpaid at the time of the reform-then equivalent to 29 percent of the average wage. However, the law stipulates that the base will remain unchangeduntilits value falls to 12percent of the average wage. For the component reflecting work prior to 1996, the benefit amount is equal to 1 percent of the final average pre-1996 wage for each year of prior work. However, this component cannot exceed 15 times the minimum wage - currently a ceiling of 1500som. The component for work since 1996i s calculated on the basis o fthe 99 notional capital that the worker has accumulated in an account under his or her name in the Pension Fund. This notional capital is equal to the cumulative, indexedvalue o f the worker's contributions from January 1, 1996, until he or she retires. The cumulative contributions are indexed annually to reflect 75 percent o f wage growth in the previous year. Inreality, however, these contributions are not saved and accumulated but are paid out immediately as benefits to existingpensioners. 269. The amount of benefit is calculated by multiplyingthe retiree's notional capital by a coefficient that reflects life expectancy for all men and women (ignoring gender differences) at the specific age when the person retires. The relative importance o f the three components i s expected to change over time (Figure 7.1). The component reflecting contributions before 1996 to the old pension system gradually diminishes in importance as, within the stock o f pensioners, new retirees with less time working under the old system gradually replace retirees who began receiving pensions soon after 1996. Conversely, the component reflecting contributions after 1996 to the new (current) pension system gradually increases in importance. Once the base pension has converged to 12 percent o f the average wage, its share in new pensions awarded remains fairly stable over time. The PensionFund i s also obliged to pay health insurance premiumsfor pensioners equivalent to about 3 percent o f pensions. The law does not specify any rules for indexing pension. Figure 7.1 Simulationof the Shareof Each Componentinthe Calculationfor New Benefitsin the Future I 100, 50 I 0 1998 2003 2008 2013 2018 2023 2028 2033 270. Social insurance contributions are to be paid monthly by all working people. Employees pay 29 percent o f their gross eamings. Independent farmers pay an amount equivalent to the land-tax, which reflects the size and characteristics of their land. Self- employed people must contribute 1.25 times the minimum wage (about 125 som in 2002). The State budget finances additional benefits for privilegedgroups and pensions for early retirees, as well as all or part o f the pension system's current deficit (on a grant basis). Any remaining deficit leads to arrears in payment o f pensions or to delayed 100 transfers o f the social contributions payable to the Health, Employment and Social Insurance Funds. 271. Social Assistance. Allowances for families with children also gave way to new social assistance policies, as the inherited system was both expensive and very poorly targeted. In 1995, a new targeted social assistance benefit, the `Monthly Common Subsidy,' was introduced to compensate the poor for the phasing out o f certain consumer subsidies. InMay 1998, a "Law on State Benefits" established a new Unified Monthly Benefit (UMB) as the basis for a simplified and unified cash social assistance policy. UMB is designed to guarantee a minimum income under means testing, and is to be adjusted annually in line with an assessment o f needs and available fiscal resources. Targeting social assistance inthe current environment, however, has proved challenging. Moreover, spending on UMB and means-tested programs dropped from 4 percent o f GDP in 1995 to 0.6 percent o f GDP in2001 (Table 7.1). 272. The Kyrgyz social protection system currently includes several different types o f assistance using different approaches and criteria. The systems include privileges, energy-related price discounts with and without income-testing, social benefits, Unified Monthly Benefit (which i s income- and asset-tested), and other general price subsidies. Social assistance benefits remain unduly low, imperfectly targeted, and paid largely in kind.Recent quantitative analyses o fthe impact andeffectiveness are limited. Additional analysis o f related issues i s anticipated for the second volume o f the poverty assessment, currently inprocess. However, available information suggests that targeting o f assistance i s far from perfect. Most extremely poor families receive no help and much help goes to non-poor families. Benefits are typically small, and administrative costs per som of targeted assistance deliveredappear high. 273, Employment Policies. Kyrgyz employment policies-as these are understood today-evolved since independence. When central planning collapsed, people faced uncertainty about income and job tenure for the first time. Unemployment, especially disguised unemployment, rose sharply and contributed to the substantial growth in poverty. Initial policy responses to weak labor markets followed OECD models, which proved inappropriate for Kyrgyz circumstances. The employment service was reformed, unemployment benefits were introduced, and the vocational training system was upgraded to anticipate demand for new skills. As the economy declined further, funding for these new systems could not be maintained. The government then introduced further active labor market programs, especially training and development of small businesses.lo3 2. Social Protection Expenditures 274. The aggregate level o f social expenditures (on budget) was estimated at 6.3 percent o f GDP in 2001 (Table 7.1). This was just over half its corresponding share in `03 Abrahart Alan. Kyrgyz Republic Employment Policies: Facing East. Paper prepared for the Ministry of Labor and Social Protection Seminar, "A Strategy for Social Policy of the Kyrgyz Republic as a Framework for the `SOSAC' Project." Bishkek, September 24-26, 1997. 101 1995. More detailed decompositions of pension spending in 2001 are provided inTable 7.2. Table 7.1 Kyrgyz Republic, Social Expenditure of Consolidated General Government 1995-2001(1,2), (as share of GDP) 1995 1996 1997 1998 1999 2000 2001 Total Social Protection, of which 12.1 9.6 8.3 7.8 6.5 5.7 6.3 Social Insurance, of which 8.1 7.6 7.2 6.9 5.6 4.9 5.1 Pensions 7.2 6.9 6.5 6.3 5.1 4.4 4.7 Social Insurance 0.7 0.5 0.4 0.4 0.3 0.2 0.2 Employment 0.2 0.3 0.3 0.2 0.2 0.2 0.2 Social Assistance, of which 4.0 2.0 1.1 0.9 0.9 0.8 1.2 Allowances to Poor Families(3) 4.0 1.8 1.0 0.7 0.7 0.3 0.6 Social Allowances *. 0.2 0.1 0.1 0.1 0.1 0.1 Child Allowances (4) .. 0.0 Privileges(4) .. 0.4 0.5 1/Includesthe Republicanand local budgetsandthe extra-budgetary funds. 21 Expenditureis providedon a cash basis. 3/ / SpendingunderUnifiedMonthlyBenefit(Le. the only means-testedprogram). 4 Before 2000 was not reported as separate line iteminthe budget. Source: MOFofKR, National Statistics Department, WB staffcalculations. 275. Revenuesfor the contributory social insurance system come primarily from wage- based contributions. In 2001, firms contributed 58 percent of the total, budget organizations 28 percent, and the state budget 11 percent. Farmers and agricultural organizations together contributed only 3 percent, and the self-employed contributed nothing. Spending on age pensions (74 percent of the total) dominates spending on disability and survivor pensions (7 percent each), with spending on other benefits and administration eachabsorbing 3 percent. 102 Table 7.2: Decompositionof Pension Spending,Pensioners,PensionFund Revenue,and PensionFinancing,2001 200 1 % o f GDP % o f total I.Totalpensionspending,ofwhich 4.7 75.3 Labour pensions 4.2 66.8 N o n contributory pensions, o f which 0.5 8.6 Military pensions 0.2 2.5 High mountain residents' pensions 0.1 1.4 Allowances to disabled, injured, special supplement 0.1 1.2 Other pensions (mothers with many children) 0.2 3.2 Pensions for special acheivements 0 .o 0.3 000 persons YOo f total 11. Total number o f pensioners 529 100 2.1. Pensions Regulated by Public Pension Social Insurance Law, O.W. 2.1.1. Labour pensions, ofwhich 525.8 99.4 2.1.1.1. Old age pensions, ofwhich 416.2 78.7 less than 200 soms 5.1 1.o 301-400 soms 18.8 3.6 401-500 soms 134.4 25.4 501-600 soms 95.3 18.0 601-700 soms 64.4 12.2 701-800 soms 42.9 8.1 801-900 soms 25.2 4.8 more than 1000 soms 30.2 5 . 7 2.1.1.2. Invalidity pensions (average 414 soms), o f which 5 5 . 5 10.5 2.1.1.3. Survivors (number o f families, average 378 soms) 51.8 9.8 2.1.1.4. Privileged Pensions 2.3 0.4 2.2, Regulated by the Law on Military Pensions 3.2 0.6 YOo f GDP % o f total 111. Total pension fund revenue, o f which 4.56 100.o 3.1 Total payroll revenue, o f which 3.84 84.2 Budget entities 1.14 25.0 Other 2.70 59.2 3.2 Transfers from State Budget, ofwhich 0.56 12.2 Military pensions 0.18 3.8 High-mountain pensions 0.09 1.9 Military state insurance 0.02 0.4 Supplement for labor injuries 0.02 0.4 Supplement to invalids 0.06 1.3 Supplement for distinguished services 0.02 0.4 Pensions for mothers with many children 0.18 4 .O 3.3 Other revenue (dividents from shares in SOEs, etc.) 0.16 3.5 I V . Pension financing financing. O f which 0.2 100.0 Subvention from state budget 1/ 0 .o 0.0 Arrears acumulation 0.1 41.7 Borrowing from the Health Medical Insurance Fund 0.1 58.3 Source: Social Fund. 3. Other Expenditures Related to Broad Social Objectives 276. At independence,the distribution of earned incomes was relatively flat and their nominallevels were relatively low. However, an extensive system of price subsidies for consumer goods and services enhancedthe purchasingpower of these incomes. These 103 consumer subsidies can be regarded as a system o f quasi-fiscal, off-budget, implicit expenditures for social protection purposes. Typically, however, they are not well- targeted towards lower-income households. Although many price "privileges" remain, most price subsidies for consumer staples have been eliminated or substantially reduced. One notable exception has been energy prices, where consumer subsidies remained fully in place until 2000, when they began to fall as part of a strategy for reforming and rejuvenatingthe energy sector. 277. Estimates o f these off-budget expenditures for energy, relative to budgetary outlays for social protection, show them to have been very large (Table 7.3 and Figure 7.2). Moreover, the energy subsidies generally rose over the second half o f the last decade, whereas the budgetary outlays on social protection generally fell. Quasi-fiscal expenditure is measured as the cost of two elements: (i)transmission and commercial losses above what would be acceptable by international standards, on the assumption that these mainly reflect lax disconnection policies; and (ii)the difference between the statutory tariff and an estimated long-run marginal cost for the sector (US$2.3 cents/kWh). Table 7.3: Budgetary Social Protection Expenditures and Quasi-fiscal Price Subsidies for Energy, 1995 - 2001 (In percent of GDP) 1995 1996 1997 1998 1999 2000 2001 Total Budgetary Social Protection Expenditures 12.1 9.6 8.3 7.8 6.5 5.7 6.3 Quasi-fiscal expenditures on Energy Subsidies 7.2 4.8 5.5 6.4 10.1 8.9 5.9 Sum o fBudgetary and Quasi-fiscal Expenditures 19.3 14.4 13.8 14.2 16.6 14.6 12.2 Source: MOF of KR, National StatisticsDepartment,WB staffcalculations Figure 7.2: Kyrgyz Republic: Evolution of Direct Social Spending and Implicit Social Subsidies, 1995-2001 T 44.0 43.0 42.0 41.0 40.0 -1 39.0 2515 00 01 2 ~ 95 96 97 98 99 1- CumulativeExplicit Social Spending -Cumulative Quasi-fiscalsubsidies 1 Note: Budgetary social spending includes health, education, social protection, and pensions. Quasi-fiscal expenditure is measured as the cost of two elements: (i) transmission and commerciallosses above what would be acceptableby internationalstandards, to the extent that these mainly reflect lax disconnectionpolicies; and (ii)the differencebetweenthe statutory tariff and an estimatedlong-runmarginalcost for the sector (US$2.3 centslkwh). Sources: Dataprovidedby the authorities;authors' calculations. 104 278. A further way to put budgetary expenditures for social protectioninperspective is to compare them with other categories o f social expenditures, such as those for health and education. Pensions represent a larger share o f social spendingthan that for either health or education, both of which are larger than spending on social assistance programs (Figure 7.3). Figure 7.3: Kyrgyz Republic-Composition of Social Spending, 2001 Education, 30.4% ealth, 15.5% Security (other), 3.4% Source: MoF, SF, and WB staff indicators B. EVALUATING CURRENT SOCIAL POLICIES AND EXPENDITURES 1. Pensions 279. The 1997 pension reforms redefined current and future pension entitlements so that past entitlements to improve financial sustainability, and so new entitlements reflect the expected long-term revenues o f the Pension Fund. The rising retirement age and the elimination o f many early retirement privileges are expected to raise the average number o f contributors per pensioner, improving the system's fiscal health. 280. Accordingly, ifpolicy makers choose to adopt a conservative approach to pension policy, long-term projections indicate the possibility o f expenditures converging to about 3.5 percent o f GDP -which would allow a reduction in the payroll contribution rate, as a deliberate policy choice as the economy expands. 281. So far, the 1997 reforms have generally been delivering broadly what they promised (including a spread o f pension benefits around the mean o f US$10 dollars) and they seem likely to continue to do so if policy makers make consistently disciplined choices. Pension expenditures reached their lowest share o f GDP in 2000, when they represented 4.0 percent o f GDP. As reformers expected, the system was balanced in 2001, although this was achieved partly by co-opting social insurance raised for health 105 and other purposes. Since 2000, the increase inpension expenditures on current benefits, as a share o f GDP, has been due primarily to a faster increase in pensions than inprices, rather than to a particularly highburdenof new benefits (either in the level or number o f pensioners). Accordingly, expenditures on pensions from social insurance are expected to reach 4.4 percent o f GDP in 2002, after including the recent increase in May. This estimate excludes expenditures on (a) pensions for military personnel and policemen, and (b) administrative costs, which together amount to about 0.5 percent o f GDP. The financing gap in 2001, which was covered by planned State Budget transfers, was about 0.5 percent o f GDP. It i s expected to be about 0.7 percent o f GDP in2002. 282. Nevertheless, there remains unfinished business from the 1997 reform agenda. The failure to legislate an intendedmechanism for indexingpreviously awarded pensions in a sustainable way has made the system's financial health dependent on continued prudence and restraint by policy makers. Steps to eliminate in-kind collections and payments must be completed successfully. Institutional developments are also needed: (i)improvecollectionperformance;(ii)createamuchstrongerinformationbaseon to to differences betweenand withinpensioner subgroupsinpatterns o f household income and in economic and social characteristics including energy use; (iii)to establish more transparent accounting systems that meet international standards; and (iv) to improve record-keeping, auditing, and other technical requirements for efficient administration. Moreover, the timing during the year o f State budget transfers and o f the collection o f revenues must be matched better with the pattern o f disbursements required to pay pensions on time so that arrears inpension payment during the winter and spring periods (as in 2001) can be avoided. In 2001, this situation implied, not only arrears, but also some "predatory borrowing" from revenues collected for the Employment and Health Funds. 283. There are other short-term, medium-term, and long-term policy concerns: 0 First, the system is under current and medium-term fiscal pressure. Striking evidence comes in the way in which pension spending continues to crowd out important health expenditures by diverting revenue collected for the health and employment social insurance programs. Moreover, although budget transfers are programmed to finance benefits outside the insurance framework, additional transfers will be required at least until 2004 to offset the cut o f 3 percentage points in the rate o f pension insurance contributions that took effect in 2002. Further increases in pensions above prices before 2005 would lead to arrears unless they are offset by additional budgetary transfers. 0 Another medium-term problem i s that, even with relatively strong economic growth, it will be at least 2009 before average pensions reach the poverty line or base pensions reachthe extreme poverty line. 0 A key long-term problem is that coverage of the current contribution-based pension system is projected tofall gradually to 70 percent in year 2040 ifcurrent patterns o f contribution (and non-contribution) to social insurance persist. The 106 proportion of new retirees, disabled people, and survivors who qualify to receive pensions would also fall. This is because only 60 -70 percent of the current labor force is insured for pensions and so will have satisfied the new requirement for years o f contributory employment. Hence, the number of beneficiaries will slowly converge to the number of insured. Furthermore, a key reason for the low participation rates is that contribution rates are already so high that they discourage formalization ofthe economy andthus enlargement of the contributory base. 0 Finally, the stock of pensioners (excluding military personnel and police) i s expected to continue to decrease until 2007 and will then increase. However, the ratio o f contributors to pensioners will remainrelatively high because the current population is young, the proportion of working-age adults i s increasing, and future pension entitlementswill be limited to those contributors who have been insured. 284. More importantly, policy makerswould like the systemto provide larger pensions more quickly than the pension system adopted in 1997 was designed to deliver. This desire results from recognition that the purchasing power of pension benefits remains inadequate for many if not most pensioners. For example, the average pension i s only two-thirds of the general poverty line; and the base pension is about two-thirds of the extremepoverty line - which inturncovers only the food budget incorporated within the general poverty line. 285, These concerns about poverty among pensioners are certainly appropriate. Pension benefits play an important role in alleviating poverty among Kyrgyz pensioners. For example, analysis shows that pensions reducedpoverty among pensioners in 1998 by 12 percentage points (Table 7. 4). Ifpensions had not been paid, but if everything else had remained the same, the poverty rate for all pensioners in 1998 would have been 67 percent instead o f 55 percent. Moreover, this estimated effect i s statistically robust. The most important impact of pensions on poverty i s among aged pensioners above the standard retirement age. Had pensions not been paid, poverty among this group would have been higher by 14 percentage points. Similarly, in the absence of pensions, the average rate of extreme poverty among aged pensioners would have been 30 percent insteado f 18 percent. Risk ofPoverty Risk of Poverty ifpensions were not paid Type of population average 95% confidence average 95% confidence interval interval Total Population 0.64 0.60 0.67 0.65 0.62 0.69 Total pensioners 0.55 0.50 0.60 0.67 0.63 0.71 Old-agepensioners 0.53 0.48 0.58 0.67 0.62 0.71 107 286. Figure 7.4 compares two relationships to show how the impact o f pensions varies by pension level. The solid line and the left axis show the risk o f poverty among pensioners by increasing level o f pension. The broken line and the right axis show, by increasing level of pension, the average proportion o f the poverty gap that the pension benefit covered. (The poverty gap for a family is the difference between its poverty line and the sum o f its members' expenditures if no pensions had been paid to them). The figure shows that, regardless o f the level o f pensions, some pensioners are poor. It also shows that pension benefit helpedcover just under 30 percent o f the poverty gap o f those pensioners receiving the lowest pensions. Poor pensioners and their families remain poor or very poor after receiving pensions. However, even the very small pensions these families receive make a difference in their poverty outcomes. As one moves from the pensioner groups with the lowest pensions to those with the highest, their risk o f poverty generally decreases, while the proportion o f the poverty gap that their pensions cover generally increases. Figure 7.4: Risk of Poverty and Amount of Poverty Gap Coveredby Pension Benefit (by Increasing Level of Pension) j 80% I I 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 1 - 2 3 4 5 6 7 8 9 10 - - - Risk of Poverty (left axis) Percent of Family Poverty gap covered by Pension Benefit Source: Kyrgyz Pensions Policy Update,2002. 2. Targeted Social Assistance and Other Social Protection Expenditures 287. Further quantitative analysis of available information on social assistance expendituresand other social protection expenditureswould be neededto provide a more current and detailed basis for recommendations for improvements inthe following areas. 288. Unified Monthly Benefit. Social assistance is often characterized as involving multiple objectives o f income adequacy, work incentives, and expenditure containment, which are then seen as implying target-efficiency as an intermediate goal. Economists note, however, that target efficiency has little to do with economic efficiency inresource use and, indeed, usually makes this worse. Thus target efficiency i s only one criterion o f good performance among others. 108 289. The formula that i s used to calculate the minimum consumption guarantee yields that maximum level for the consumption guarantee that is affordable within a budget ceiling equal to 1.5 percent o f GDP, given the estimated number o f UMB benefit recipients, the estimated average income o f UMB recipients, andthe estimated number o f social benefit recipients. In recent years, however, until a decision in April, 2001, the minimum consumption guarantee under the UMB was not revised upwards, despite inflation, for fiscal reasons. Consequently, its real value had dropped and fewer families than otherwise met the increasingly stringent standard. With recipient numbers and the real level o f benefits both held down inthis way, UMB program expenditureshave fallen below the threshold o f 1.5 percent o f GDP. Within the UMB program, 40 - 60 percent o f benefits are paid inkind. 290. Employment Programs. The Bank's 1999 Review o f Social Expenditures drew attention to three pertinent questions that policy makers might wish to address further concerning Unemployment Benefit. First, can an unemployment insurance program be administered satisfactorily in an environment where determiningwhether an individual i s involuntarily unemployed i s extremely difficult? Second, i s unemployment insurance viable and appropriate in the context o f a dramatic and sustained slump in economic output and when a large number o f people have frequently faced significant arrears in wages and benefit payments? Third, i s unemployment insurance the best use o f social protection funds, given the size o f the informal sector, the inability to verify employment status effectively, and the broader economic context? 291. Reviews o f active labor market programs in the Kyrgyz Republic have raised serious questions about significant differences across programs intheir economic benefits relative to their costs. 292. Social Services. There i s an absence o f community services for children and families. This highlights the issue o f priorities among various forms o f social protection spending, as well as the broader questiono fpriorities between social protection and other areas o f government spending. 4. Clarifying Social Priorities 293. This PER has argued that policy makers must clarify social priorities and streamline expenditures accordingly. For pensions, a crucial policy issue i s to clarify priorities among the multiple and partly conflicting objectives o f pension systems. These now include: replacing pre-retirementearnings so as to smooth income across a worker's lifetime; assuring adequate income to alleviate poverty; and usingfinancing arrangements that minimize distortions inlabor supply and inparticipation inthe formal economy. 294. Policy makers must consider whether clarifying social priorities should mean giving higher priority to improving benefit levels for the poorest pensioners and, conversely, giving lower priority to the proportion o f pre-retirement earnings that pensionsreplace. 109 295. An equally important task is for policy makers is to definethe directions inwhich they do not want the Kyrgyz pensionto move and to rejectproposals that would move the system in those directions. For example, rolling back or rescinding the increases in the normal retirement ages for men and women that began to be phased in during 1999 would undermine the emerging financial basis for a sustainable pension system that can offer adequate benefits. 296. Reforms, however, will have to be designed within the basic constraint o f an "unfunded" or "pay-as-you-go" pension system: Numberofcontributors x Average contribution=Number of pensioners x Average pension. 297. More generally, to finance more generous indexation o f pensions or to lower contribution rates for contributors, policy makers will needto adopt additional measures designed to increase revenues or reduce expenditures in the current system. Such measures include: strengthening compliance (the number o f workers contributing or the average declared wage per worker); improving the efficiency o f collections and their enforcement; further increasing the retirement age; and phasing out benefits or early retirement privileges that no longer meet a clear purpose. These same measures would also help to strengthen the adequacy o f pension system finances and would thereby help make it possible to finance expanded coverage o f the future retiredpopulation. O f these measures, raising the retirement age further would have a twofold impact once it takes effect, because it would simultaneously increase the contributor base while reducing the average duration o freceipt o f a pension. 298. Another major issue for policy makers i s whether (and if so how) to pursue a transition to a "funded" or "accumulative" basis for the pension system - one in which pensions are financed from individual accounts for each worker that have accumulated from savings over the worker's lifetime and from the interest income derived from wise investment o f these savings. (The National Poverty Reduction Strategy includes such a commitment.) Within the current system, the component o f the benefit formula based on post-1994 contributions, which was expected eventually to predominate, i s linked to a notional account that measures cumulative contributions. Higher cumulative contributions result inlarger pension benefits, thus encouraging lifetime participation and contributions. But the account i s only notional. As inother unfunded or "pay-as-you-go" pension systems, all contributions to the pension system have been immediately paid out to existing pensioners as pension benefits. Advocates o f switching to a funded system would like to replace notional accounts with accounts that really accumulate invested funds. Numerous prerequisites are needed for such a system to be viable but, even though many o f these are highly desirable, they will take years to put inplace. There are also potentially major costs for individuals, the budget, and the economy as a whole in attempting such a transition. Detailed feasibility analysis should therefore precede any irrevocable commitment to this path inthe next few years. 110 c. OPTIONSAND RECOMMENDATIONS 1. DecideAmongthe VariousPensionObjectives 299. Maintain the 1997 Strategy. Continue to balance the multiple objectives o f income adequacy, earnings replacement, fiscal balance and sustainability, and gradual * decreases in the contribution rate for pension insurance. Index pensions, once awarded, to changes in a consumer price index. Recognize that more adequate pension levels will flow only to newpensioners, once economic growth raises real wages. 300. Emphasize Adequacy of Incomes Over Earnings Replacement. Define the objective operationally as eliminating pensions that are less than the extreme poverty line. Next, freeze payments under the current pension system at their current nominal levels. They add a fourth component, supplementary assistance, to the payments due under the current system. Channel all future funds available for pension increases into this component. Use it to top up the lowest pensions first. Gradually increase supplementary pensions until, for those with no entitlement to pension from the earnings replacement components, it reaches a ceiling level equal to the extreme poverty line minus the base pension. This could be done either with current funding only, or with current funding plus any additional budgetary transfers available. Recognize that this would let the purchasing power o f larger pensions decline or grow more slowly and that it would also reduce the incentive for workers with higher incomes to participate inthe pension system and to contribute to it. 301. Once the operational objective has been met, start to unwind the revised system. First, increase supplementary assistance payments in line with the indexed value o f the extreme poverty line. Second, use remaining revenues for pension increases to raise pensions with earnings-related components progressively to the levels they would have had in the absence o f the freeze. This process would, once again, top up pensions "from the bottom up" as funds permitted. 302. Combine previous Option with Slower Reduction in Contribution Rates. Delay gradual reductions in the contribution rate. Redirect those resources within the pension system to improving the adequacy o f benefits, enabling the objective o f Option 2 to be achieved faster. Recognize that the total tax rate on earnings would remain very high and, as a consequence, there would remain very substantial disincentives that discourage: participation in social insurance arrangements; growth in formal employment; efficient use o f labor (and, indirectly o f capital); and new development within the private sector. [Note. Present expectations are that the reductions would gradually lower the overall contribution rate from 29 percent o f the gross wage to 21 percent, and the portion o f these contributions that would be recorded in the individual accounts from 23 percentage points to 15 percentage points. Under this option, those reductions would be scaled back inwhole or part or slowed down.] 111 2. IdentifyPrerequisitesfor Introducinga FundedPensionPillar 303. The National Poverty Reduction Strategy includes a commitment to pursue a transition to a "funded" or "accumulative" basis for the pension system. This approach seeks to replace notional individual accounts with accounts that really accumulate invested funds. Such a system has numerous prerequisites. Accordingly, initiate analyses to identify the prerequisites for introducing a fundedpension pillar, to determine the actions required to meet those prerequisites, the time needed to complete these actions, and the proper sequencing o f these activities. Identify the costs for individuals, the budget, and the economy as a whole inattempting such a transition. Complete these feasibility analyses before taking any irrevocable steps towards implementing this approach. 3. ImproveCollectionEnforcement 304. Develop a modernization system for the revenue system that addresses arrears in payment, evasion o f contribution obligations, and the high rate o f participation in the informal economy. Increase integration o f social security contributions andthe collection o f personal income, land, and patent taxes. Enforce a strict separation o f the account for contributions to the MHIF, and to prevent the diversion o f health resources to finance pension payments. Adjust contribution rates to eliminate current indirect flows of revenues to the MHIF fund via the pensionand employment funds. 112 8. THE TRANSPORT SECTOR A. THETRANSPORT SECTOR TODAY 1. Infrastructure 305. Roads. Road transport is the predominant transport mode, accounting for 62 percent of freight ton-km and 86 percent of passenger movements. The road network under the Ministry of Transport and Communications (MOTC) totals almost 19,000 km (Table 8.1). This gives a road density o f 0.09 km2 and 4 km/1,000 inhabitants, which is comparable with that of countries of similar size. The road network i s generally adequate for the needs of the country. In addition, there are 15,000 km of farm access roads, which are outside ofMOTC's jurisdiction. These roads, whichwere built andmaintained by state and collective farms, are now inprincipleunder local administrations, whichlack the financial resourcesto maintainthem. Table 8.1: Classificationof Roads by Function,2002 Function Length (km) International 4,000 National 5,678 Local 8,995 TOTAL 18,829 Source: MOTC Roads Department,May 2002. 306. There are only 145 km o f four-lane roads (15 m wide) (Table 8.2). Other asphalt- paved roads (9,316 km) are two-lane, ranging from 6 to 7.5 m in width. The remaining 9,461 km are gravel roads, most of them 5 m wide. Roads at all levels are deteriorating; according to some estimates, 60 percent now require periodic maintenance or rehabilitation.lo4 307. The Road Department of MOTC is responsible for managing the road sector. Underthe Road Department, there are seven regional maintenancedistricts (RMDs), one for each oblast and a separate one for the Bishkek-Osh road. Units under the RMDs, generally covering roads in one rayon, perform the actual maintenance work. In 2002, there were 58 such units, with a staff o f 3,155 persons. Except for a few new pieces of maintenance equipment purchased under ADB and Japanese loans, most of the equipment has exceeded its economic life and operates only poorly between frequent breakdowns. '04ADB, Third Road RehabilitationProject, Appraisal Report. 113 Table 8.2: Classificationof Roads by Type of Surfaceand Width, 2002 Class and SurfaceType Traffic Volume Width o f Length (vehicle/day) Lanes(m) (km) Asphalt Roads ClassI >14,000 4 x 3.75 145 Class I1 6,000 to 14,000 2 x 3.75 483 Class 111 2,000 to 6,000 2 x 3.5 2,192 Class IV 400 to 2,000 2 x 3.0 6,641 GravelRoads Class V <400 2 x 3.0 2,064 ClassV I <200 2 x 2.5 7,397 Total 18,922 Source: G. MetshiedGTZ,Financing UrbanRoads in Kyrgyzstan,May 25,2001. 308. Because of the limited budget, road maintenance in recent years has covered only halfof the network under MOTC. This leaves the local roads virtually unattended, except in cases o f emergency repairs after landslides, flooding, etc. Over the last five years, periodic maintenance and rehabilitationhas beencarried out on only some 250-300 kmannually (Table 8.3). This impliesa 40 year cycle for the periodic maintenance ofthe 10,000 km o fmajor roads, rather than the more usual 7 to 10 year cycle. Table 8.3: Length of Roadsunder Maintenance, 1997-2006 1997-2001(actual) km 2002-06 (projected) km 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Total (International, National, Local) Routine 8,510 8,400 9,000 9,700 10,700 11,100 1,1950 12,750 14,000 14,100 maintenance Medium 52 179 154 20 157 171 188 207 225 247 repairs 3 Heavy 173 136 151 90 86 94 104 114 126 138 maintenance, rehab. Total 8,735.5 8,715 9,304 9,992 10,943 11,365 12,242 13,071 14,351 14,485 Source: MOTC, Roads Department, May 2002. 309. Urban roads and streets are the responsibility o f city governments. Little maintenance efforts are visible, except for the few major streets recently rehabilitated underthe Bank's urbantransport project, inthe three largest cities. 310. Railways. Kyrgyz Railways operate about 320 km o f single-track lines (with a total track length o f 428 km). There i s a main line in the north, which runs off the Kazakhstan railways in Zualy to Bishkek and Balikchi on Lake Issik Kul (220 km, o f which 60 km are inKazakhstan), and there are eight branch lines off the Uzbek railway totaling about 100 km inthe south. No rail connection exists between the north and south in the country. The track condition is basically adequate for the low level o f traffic, although wooden sleepers have deteriorated in some sections of the main northern line, leading to speed restrictions on 10 percent o f the line. The Railway Department has beguna small program o f replacing worn out wooden sleepers with concrete sleepers on that line. 114 311. In addition to Kyrgyz Railways, there is a small Railway Construction Bureau, which was originally a State Directorate under the republican government. InDecember 2000, with the streamlining of state institutions ledby the President's Administration, the Bureau was placed under MOTC. The Bureau's main purpose is to study and promote the construction of a railway line from the Chinese border (Torugart Pass) to the Fergana Valley, where it would connect to the Uzbek railway, or to Balikchi, where it would connect, through Bishkek, to the Kazakh railway. ` 312. After some years of studying various alternatives, more detailed studies are now concentrating on the route to the Fergana Valley, and tri-partite discussions have been heldwith China andUzbekistan. A feasibility study financedjointly by TACIS andADB i s about to start. Cost estimates for the 256 km section in Kyrgyz territory range from US$1.5 to US$2.5 billion. There would be two major tunnels, one of 4 to 5 km at an altitude o f 3,500 m and another of 14 km. Opening year traffic is estimated at 3 million tons, of which only 10percent would be Kyrgyz traffic. The long-term prospect could be around 10 million tons. This level of traffic clearly makes such a new railway line, in very difficult terrain, economically unfeasible. This was the conclusion of a recent study. 313. The consultants recommended the development of a "Multi-Modal South Kyrgystan Transport Corridor" rather than the construction of a new railway line. The cost would be considerably lower and the development benefits greater. Intheir terms, "the concept would be to develop a rail-road-rail corridor between the Fergana Valley andthe Western PRC, using rail to Osh, road to Kashgar andrail for the remainder of the distance to Urumqi and points beyond."'06 This would require container handling equipment facilities in Osh and Kashgar for transshipment between railcars and trucks. In any case, one transshipment would be required in the rail option because of the different gauges of the Chinese and CIS railways. The estimated cost of improving transshipment facilities at Osh and Kashgar is US$2 million. While this is a small cost, a detailed feasibility study of the minimumroad improvements neededwould be necessary prior to committing any investment. 314. Airports. There are three main airports in the Kyrgyz Republic: Manas (Bishkek), Osh, and Karakol. In addition, there are many runways that were formerly underthejurisdiction of these three major airports. Inprinciple,these runways should be devolved to local governments, but local authorities are refusing to take them over owing to lack of resources. Since there are no flights to these airports now, they are not being maintained. On May 15, 2001, the Kyrgyz civil aviation sector was reorganized into three independent entities: the national airline, the airports, and air navigation. The first two entities are joint-stock companies under the State Property Fund and the third i s a department of MOTC. ADB, Technical Assistance ProjectNo 5818-REG:RegionalEconomicCooperationin CentralAsia - Phase I1 (Post BuckleyInternational, Inc., July 2000). IO6Ibid. 115 315. The Airport Company includesthe three main airports. Only Manas Airport is at present financially self-sufficient. The other two airports are losing money. They have been attached to the company, so that the surpluses expected at Manas would cover the losses at the two smaller airports. The new company has assumedthe Japanese loan for the modernization of Manas. At the moment, with revenues accruing from foreign military aircraft, the company should be able to assume the loan payments despite its losses from the smaller airports. How long this situation will last is uncertain. If revenuesare insufficient inthe future, the state guarantee may have to be called to service the loan. A newloanis under considerationfor the renovationofthe OshAirport. 316. Conclusion. The existing transport infrastructure is adequate to serve the present transport demand. Consequently, the major concern i s maintenance and rehabilitation, rather than expansion of the system. The main issue is that under present economic conditions the country cannot affordto maintain its current infrastructure. This i s already a problem, as only about half of the road network i s being maintained, city streets are deteriorating, and smaller airports have shut down. It would be useful to define a core network that could be maintained adequately withinthe available resources (Section 3). 2. Operations 317. Transport Demand. Transport demand has fallen off dramatically since 1990. In2001,freight turnover (measured inton-km) was only 20 percent of its 1990level and passenger turnover was 57 percent of its previous level (Table 8.8). The lowest levels were reachedin 1995. The demand grew in 1996 and 1997, but freight went down again following the 1998 financial crisis. Its 2001 level was still lower than the 1997 level. Passenger transport has beengrowing at about 6 percent annually over the last five years. As a result of the reduced demand, employment in the sector is still contracting. It was about 50,000 in 2000, versus 68,000 in 1996. The sector now provides only 2.8 percent of total employment inthe country, versus 4.1 percent in 1996. Inaddition, the sector's contribution to GDP fell from 3.5 percent in 1996to 2.4 percent in2000. 318. Road Transport. Inter-city road transport has been almost totally corporatized, andthe private sector is developing rapidly. According to MOTC's Planning Department, private truckers now carry 43 percent of freight in the country, while the former state transport companies carry the rest. The latter are now joint-stock companies under the State Property Fund and use own-account trucks. MOTC retains only the international trucking company. Private buses carry 72 percent of passengers in the country. Under these circumstances, the government should sell its remaining shares in all inter-city freight andpassenger transport companies. 319. Vehicle registration numbers are difficult to obtain and are reportedly unreliable, The figures available for 1998 are given inTable 8.4. 116 Table 8.4: Vehicle RegistrationNumbers Vehicle Fleet in 1997/98 Inthousands Passengercars 197.1 Buses 13.2 Trucks 56.5 Other 39.9 Total 306.7 Source: ADB, ThirdRoadRehabilitationProject SAR, 2001. 320. According to a paper preparedfor the Osh Seminar on Financing UrbanRoads in the Kyrgyz Republic, held in April 2002,'07 the total number of vehicles in the country was only 205,000. Although the number of vehicles is open to question, the trends are clear. The number of private cars i s increasing rapidly, the number of buses is fairly stable (probably with a structural shift from large buses to mini-busesand vans), and the numberoftrucks is decreasingrapidly. 321. There are still far too many trucks for the much reduced freight transport demand. Based on the number of trucks for 1998 (Table 8.4), and road freight turnover (Error! Referencesource not found.), the average output per truck is less than 20,000 ton-km per annum. Assuming even a low average load of 5 tons, this would meanthat each truck covers only 4,000 km per year. It i s possible that many trucks still in the registry are no longer in operating condition. The fleet of.common carrier trucks and buses i s aging, and few operators have sufficient operating surpluses to modernize their fleets. 322. Urban Transport. The situation has changed little since the World Bank prepared an Urban TransportSector Review in 1998. The publicly owned operators in Bishkek and Osh still have to cater mostly to privileged passengers. For example, in Bishkek, 62 percent of passengers of the public bus and trolleybus companies are privilegedand travel either free or at a discount from fares that are already insufficient to cover costs. The operators are not compensated for their losses and are unable to cover their operating costs, let alonethe maintenance andrenewal oftheir dilapidated fleets. In 2001, 32 new trolleybuses were procured by the state under a Japanese grant. However, the trolleybus companies inBishkek and Oshthat receivedthese vehicles are supposedto pay the government back. Giventheir insufficient revenues, this is unlikelyto happen. 323. RailTransport, At the time of partition of the Soviet railways, Kyrgyz Railways received 2,500 freight cars, 450 passenger cars, and 50 locomotives (about half mainline and half shunters). All the equipment was old and obsolete. Traffic has been falling rapidly since 1990, the fall infreight being further accentuated by the financial crisis of 1998. Freight traffic is now only 13 percent of its 1990 level (330 million ton-km in 2001, versus 2,620 million in 1990) and i s still falling. Passenger traffic i s about 25 lo'E.Toguzbaev,"The Reviewofthe PresentSituationofthe Tax from Vehicle Owners," 2002. 117 percent o f its 1990 level. It reached 50 million persodkm in2001,recovering from a low o f 31million in 1999 following the financial crisis. 324. Freight traffic consists mainly o f low value bulk commodities such as cement, construction materials, sugar and sugar beets, coal, grain, and timber. Container transport has started up on a small scale (20 to 60 containers per month handled at Bishkek). Loading and unloading equipment at Bishkek was financed by TACIS. There are five international passenger trains per week from Bishkek to Russia (Moscow, Sverdlovsk and to the East). Inthe summer there i s one train per day from Bishkek to the lake. There is a basic commuter service in the Bishkek area, but there i s no passenger service on the southern branch lines. 325. After running operating deficits until 1998, the railways now operate with a small, but increasing, operating surplus that reached 72 million som in 2001 (USUS million). This was obtained by: (i)reducing staff by almost 20 percent, (1,064 staff), leaving a total staff o f 4,600 today; and (ii) reducing the number o f passenger trains. While freight services are profitable, passenger services are losing money, since fares are regulated by the Anti-Monopoly Commission. To supplement revenues, the railway manager has also started offering services to others (such as repair of privately owned freight cars, repair o f traffic signals incities, etc.). There are no public funds going to the railways at this time. With its operating surplus, the manager has started rehabilitating sections o f the northern line with concrete sleepers. H e would also like to acquire second hand passengercoaches to replace dilapidated equipment. 326. The railway is still overstaffed for its traffic level. Productivity i s about 82,000 traffic units (tkm+pkm) per employee. To place this amount inperspective, this i s half o f the productivity of the Albanian railways in 1990 and about one-tenth o f that of a more efficient railway, such as that o f Korea. Freight cars, which are well in excess o f the needs o fKyrgyz Railways, are leased to neighboring railways. 327. Civil Aviation. Air transport is now only one-tenth o f its 1990 level, for both freight and passengers. Passenger traffic fell 27 percent in 2001 from its 2000 level. In 1997, the national airline (KAJ), which also handles airports and air navigation, was corporatized, with some 82 percent o f the share remaining with the state, 8 percent being transferred to the Social Fund, and 10 percent being sold on coupons. In 2001, as has been mentioned, the Kyrgyz civil aviation sector was reorganized again and the airports and air navigationservices were separated from KAJ. 328. In addition to the national airline, 16 companies have registered to operate as private airlines. Out o f these companies, 5 or 6 have started operations. There are no subsidies from the state to either the national airline or the private airlines. However, since the airlines are losing money on domestic services, which they are forced to operate for social reasons, they receive a 50 percent discount on air navigation services and airport fees. The national airline aims at balancing its domestic losses with surpluses from international flights. However, when the airline recently had to make loan repayments, it stopped paying its pilots for a few months. Although the company shows an operating 118 surplus, the amount is evidently not enough to cover all of the airline's financial needs and to enable it to modernize its aging fleet of Russian aircraft. The company is also used for government services for which it does not always receive payments. Domestic fares are fixed by the Anti-Monopoly Commission. For Bishkek-Osh, the fare is presently 1,500 som (US$30). 329. One o f the so-calledprivate companies, Altin Air, is infact 100percent owned by KyrgyzAltin, which is itself a fully state-ownedjoint-stock company. Its advantage over the national airline onthe domestic Bishkek-Osh line i s that ituses a48-seater turbo-prop Antonov 24 built in 1977, which has the same operating cost as the KAJ 30-seater jet Yak 40 from 1973. Another advantage of Altin Air over the national airline is that the former is not burdened with overstaffing. Altin Air employs only 28 persons, while the national airline has over 1,200 employees. These two factors allow Altin Air to break even on the government-imposed fare. However, even this more efficient company reckons that it would need a fare of US$50 to be able to eventually purchase a more modern and economical plane. Giventhe low-income level of the population, there is no other domestic destination that wouldjustify air service at this point. 330. Conclusion Transport companies in all modes (road, rail, and air) are struggling financially. The demand for their services has fallen drastically since independence and the state is enforcing tariff levels that are, in the best cases, barely sufficient to cover operating costs. In the case of passenger transport, the situation is made even worse by the numerous privileges accorded to large classes of the population, particularly inurban transport. Equipment i s grossly over-aged, difficult to maintain and therefore very inefficient. Largely state-ownedjoint-stock companies are still overstaffed given the falling demand. 3. Roleof the Public Sector inTransport 331. The government has made substantialefforts to get out oftransport operations and to concentrate on the policy, planning, and regulation of the sector. The staff of MOTC i s gradually being reduced. The latest reduction, in February 2002, cut another 23 percent of the staff, and a further 5 percent reduction must take place over the coming months. By the end of 2002, MOTC should have 316 staff, of which only 82 will be in Headquarters,dealing with policy andplanning (Figure 8.1). 332. The RoadDepartment has only 18 staffmembersat Headquarters, of which 10 are invarious project PIUs. This is clearly too few to adequately planand managethe road network. The bulk of MOTC's staff (179 persons) works in the Transport Inspectorate. This office issues road transport licenses and inspects and regulates road transport services, The Civil Aviation Department (42 employees) performs similar activities in the field of air transport. It inspects pilots and aircraft, and issues registration and fitness certificates as well as licenses to operate certain routes. 333. Although the government withdrew from directly providing road and air services, it still maintains very large holdings in the joint-stock companies operating these 119 services. The railways are still attached directly to MOTC, together with Kyrgyz Post and a number o f smaller operations, such as Kyrgyz International Transport, the Intercity Bus Stations, etc. The influence o f the government is still particularly strong in the market o f inter-city and urban passenger transport. The Inspectorate issues route licenses and mandates levels o f service. Buses must operate out of government-owned bus stations. There are 23 categories of privileges that give many passengers discounts on inter-city travel as well as urban transport. Freight services are more competitive and customers are free to negotiate price and service quality directly with the operators. Inits recent loan (Third Road Rehabilitation Project), ADB included technical assistance to "analyze the markets for transport services and provide recommendations to improve competitiveness o fthese markets," an area that i s essential. 3. PUBLIC EXPENDITURESTRANSPORT IN 1. Capital Expenditures 334. Inrecent years, almost 90 percent o f expenditures inthe transport sector went to investment( Table 8.5), leaving little resources for maintaining the system. The road sub-sector was the single largest item in the state's Development Budget, taking about one-third of all investments in the country. The bulk of road investments went to the reconstruction of the Bishkek-Oshroad. Other investmentsincluded urban roads and airports. 335. Loans for the Bishkek-Osh road from ADB and Japan total US$220.8 million (three ADB loans and two from Japan). Including about 20 percent in counterpart funds, the total project cost is about US$275 million. Spread over 8-10 years, this means an annual expenditure o f about US$30 million. This i s seven times the average maintenance expenditure on the 19,000 km o fthe network under MOTC. The Bishkek-Osh road is the main link betweenthe northern and southern parts o f the country, which are separated by high mountains. The importance o f this road to the country is greater than would be indicated.by a strict economic returncalculation. 336. The largest other investment inthe sector was for Manas Airport inBishkek, with a Japanese loan o f about US$57 million in 1996. The project was completed in2000. A smaller loan from IDB i s presently under consideration for modernizing Osh Airport. The Bank has lent US$20 million for urban roadrehabilitation and maintenance. 337. Counterpart funds for these foreign-financed projects have absorbed almost 50 percent of the domestic transport budget over the last three years. This will be the same for 2002. The need for counterpart funds will gradually decrease as the Bishkek-Osh road i s completed, provided that no further large borrowing occurs inthe meantime. 338. Counterpart funds for the PIP are usually planned short o f expected disbursements, giving rise to budgetary arrears to suppliers o f goods and services under the PIP. This i s apparently carried out with the hope o f increasing foreign disbursements, and would not be the practice under more realistic budget planning. This practice has many negative implications when contractors are delayed because of non-payments from 120 the government. Also, because of lack of confidence, future bids are likely to be inflated to incorporate late payment risks. As of January 2002, accumulatedarrears accounted for 45 percent o f actual counterpart financing in 2001. To add to this, a substantial share of counterpart funds is provided in kind through "off-setting arrangements." In 2002, 20 percent of total counterpart funds financing provided through May was inthis form rather than incash. Table 8.5: Kyrgyz Republic: Transport Sector Expenditures,1999-2002 (inMillion Som) Actual Budget 1999 2000 2001 2002 PIP (Foreign Fundsonly) Bishkek-Osh Road 1,049 1,62 1 1,234 887 Bishkek-GeorgievkaRoad 0 0 0 48 Manas Airport 930 492 0 Osh Airport 0 0 0 25 Air Navigation 13 0 0 UrbanTransport 0 64 156 255 Total Foreign 1,992 2,177 1,390 1,215 Foreign % o f GDP 4.1 3.3 1.9 1.5 DOMESTIC Counterpart Fundsfor PIP 319 212 135 221 Other Investments 11 43 7 Road Maintenance & Rehab 141 139 203 182 Other Goods and Services 'I 37 56 28 Miscellaneous " 16 13 42 25 Total Domestic 524 463 415 428 Domestic % o f GDP 1.1 0.7 0.6 0.5 GRAND TOTAL 2,5 16 2,640 1,805 1,643 InYOofGDP 5.2 4.0 2.4 2.1 Memorandum items: Investment in % oftotal 92 92 85 87 Road Fund Revenues 31 184 656 614 I'Probablyincludedsubsidiesfor urbantransport inBishkek,nowthe responsibilityof local government. "Includeswagesandsalaries. 3/ Although the Road Fund does not exist, the Treasury keeps accounts on two sources ofrevenues. Sources: For 1999 to 2002, Treasury Department o f MOF, PIP, Ministry of Transport, May 2002. 121 2. Current Expenditures 339. Almost 90 percent o f MOTC's budget goes to road maintenance (Table 8.6), the remainder being used mainly for salaries and miscellaneous costs o f Headquarters, the two Inspectorates for road and air transport, and the courier service. This last will soon be separated from the ministry and its services will be out-sourced. 340. Road maintenance expenditures increased from about US$3 million in 1999 and 2000 to US$4 million in2001. The 2002 budget i s 10 percent lower. For the first time, in 2002, the maintenance budget shows a separate amount for the Bishkek-Osh road, a condition o f the ADB loans. As a result, since so little i s spent on maintenance, this road (about 3 percent o fthe network) will absorb 22 percent o f the maintenance budget. Table 8.6: Kyrgyz Republic: Ministryof Transport Budget, 1999-2002 (in 000 Som) 1999 2000 2001 2002 Budget Headquarters 21,059 21,059 3,305 6,303 Road Maintenance 148,777 147,820 203,013 141,840 B-0RoadMaint. 3,9712 Air Transport Dept. 8,496 6,645 Inspectorate 2,808 8,355 Courier Service 1,684 3,588 4,038 3,923 Subtotal 171,520 172,467 221,660 206,778 Special Funds 785 819 0 31,672 GRANDTOTAL 172,305 173,286 221,660 238,450 Maint. In% o f budget 87 86 92 88 Road Maint. Actual 141,623 139,167 202,954 Actual in % of nlan 95 94 100 Source: MOTC, May 2002. 341. The maintenance budget falls far short o f the needs, even if maintenance i s essentially limited to the 10,000 km o f international and national roads. Because o f the difficult climatic conditions, about one-third o f the maintenance budget i s consumed by winter maintenance (snow removal, salting and sanding, emergency repairs after avalanches and landslides), as even the highestpasses are kept opened year-round. Little help i s reportedly received from the Ministry for Emergency Situations, which normally should be dealing with landslides, etc. 342. Various estimates o f maintenance needs by the Road Department o f MOTC and consultants range from US$15 million per annum for short-term preservation only, without periodic maintenance, to US$45 million per annum for long-term preservation, including periodic maintenance, and major repairs. The backlog o f road maintenance i s 122 rapidly creating a situation in which some road sections have so many potholes, of such dimensions, that the roads cannot be repairedthrough normal annualmaintenance. 343. Another difficulty is that only 30 percent of the maintenancebudgetis incash, the rest being inkind through offsetting arrangements. In2001, for instance, the Chuy Oblast maintenance district received cash only for its salaries and Social Fund payments. Providing fuel, materials, and spare parts is very complicated, involving tri-partite agreements among the Ministry of Finance, MOTC, and the Maintenance District. Furthermore, the offsetting arrangementsconcluded among these entities may not be of a kindneededfor road maintenance. For example, the unitmay receive flour, whichit will have to further exchange for bitumenor gravel. Under such circumstances, it is difficult to consider maintenanceby contract. 344. Thejoint-stock companies inroad and air transport receive no contributions from MOTC's budget. Neither does the railway, which is still part ofMOTC. These companies may receive some compensation from the Ministry of Labor and Social Protection for the privilegedfares that they haveto grant the passengers. 345. Inair transport, KAJ shows a small operating loss of 1million som for the seven months of operation in 2001. For the same period, Manas Airport shows a 12 million som surplus, which i s reduced for the overall Airport Company to 4 million som, after losses at the other two airports of Osh and Karakol. Since the assets and liabilities of the airline and airport companies and of the Air Navigation Department are not yet fully sorted out, it is difficult to pass judgment on whether these companies will be able to service their share of the debt incurred originally by KAJ. As long as foreign military revenues keep coming in, the Airport Company should be able to service the Japanese loanfor the modernization of Manas Airport. How longthe national airline canremain in business without assistance from the state i s opento question. 346. The situation is the same for the urban bus and trolleybus companies. InBishkek, the two companies combined had an operating loss of 17million som in2001, despite an allocation from the city budget of 32 million. The depreciation allowance is only 7 million som (US$140,000) for the two companies-hardly enough to sustain a renewal program. The companies are clearly headed for bankruptcy. The situation i s similar for the trolleybus company in Osh. In Osh and Jalal-Abad, urban bus services are now provided exclusively by the private sector. 347. The Railway Construction Bureau, although now under MOTC, receives its budget as an unprotectedline item of the state's "construction budget" rather than from MOTC. Since the staff of the Bureau has been reduced to 13, the budget is small at around 1.5 million som. 123 c. CONCLUSIONAND FUTURE AGENDA 1. GovernmentTransportPolicy 348. The government's transport sector policy objectives were developed with ADB's assistance (Third Project). They includethe following objectives: 0 Adequately maintaining transport infrastructure 0 Increasing cost recovery from the users of transport infrastructure 0 Privatizing transport operations and promoting competition among operators, while addressing safety and environmental concerns. 349. While good progresshas beenmade on the third objective, the first two objectives haveto date not been seriously addressed by the government. 2. Infrastructure 350. There is a needto shift expenditures from investmentto maintenanceinthe road sub-sector in order to protect the infrastructure before it is too late. In recent years, counterpart finds for investment (PIPS) have been one-and-a-half times as large as maintenance expenditures. Adding those funds to the present maintenancebudget could provide about 400 million som (US$8 million) per year for maintenance, This would still fall short ofthe estimatedrequirementof 700 to 1billion som (US$15 to 20 million). 351. Clearly, the priority is to complete the rehabilitation of the Bishkek-Osh road as soon as possible, to overcome the "hump" in investments and to free up resources for maintenance. This will be necessary to avoid the complete destruction of many parts of the network. Consideration should be given to increasing the counterpart funding over the next two years inorder to speed-upcompletion, which i s presently planned for 2005. Earlier completion would mean that better maintenance could be started earlier for the rest of the network. 352. In the meantime, MOTC should develop and submit to the government some maintenance scenarios that indicate what size network would be maintained, at what standard, for what level of resources. There should be a range o f options, with each option fairly costed, on the basis of an inventory of the present conditions of the network and traffic levels. This should be worked out over the next 18 months to two years, with a view to reaching a broad agreement and understanding within various branches of the government of a realistic and affordable maintenanceplan for the road network. 353. Typically, it is estimated that an average of US$3,000 to US$5,000 per km per year is needed to maintain a road network in good condition, including routine and periodic maintenance on various classes of roads. Another often used indicator, which better reflects the means of countries at different income levels, is that about 1percent of GDP should be spent on road maintenance. For the Kyrgyz Republic this would mean about US$16 million per year. Table 8.7 gives some comparative maintenance budgets for countrieswith similar networks andlower GDP per capita. 124 Table 8.7: Comparative Maintenance Budgetsfor Countrieswith Similar Networks and Lower GDP per Capita GDP/cap. Vehl Network in Maintenance InUS$/km InUS$ 1000 pop. km budget,US$mn Armenia 520 95 7,788 4.2 540 Azerbaijan 610 50 23,990 11.2 470 Georgia - 590 60 21,577 13.5 625 Kyrgystan1999 260 64 18,829 3.6 191 Source: WorldBank, data for 1999. 354. In parallel, greater user financing should be sought to support the maintenance program, although this does not necessarily have to be "earmarked," given the pressing across-the-board needs o f the Kyrgyz budget. A road fund was established by law on June 1, 1998. Inits Second Project, ADB included a covenant "requiring" establishment o f a separate dedicated account for the Road Fund." Inlight o f its fiscal difficulties, the government did not establish a dedicated account outside the budget. Recognizing these difficulties, ADB waived its covenant in its Third Project. Taxes are therefore collected underthe heading"Road Fund" butrevenues are not earmarked for the road sector. Total revenues were 656 million som in2000 and 614 million in2001, while the road budgetin those two years, including counterpart funds for the PIP, were 463 million and 415 million, respectively. 355. Inany case, most of the existing road fund revenues do not come directly from road users; thus it might be premature to earmark. At present, 61 percent of the income o f the Road Fund comes from a turnover tax on industrial enterprises. Although all industries use transport, their use bears no relation to their turnover. For the same turnover, a cement plant requires far more transport than an electronic chip factory. Fund revenues directly related to road use suffer from substantial evasion o f tax payments. Because o f smuggling, the excise tax actually collected on gasoline i s less than half o f what it should be based on fuel consumption estimates, and for diesel it i s only 25 percent. It is estimated that only 70 percent o f the potential vehicle license fees are actually collected. This may be an underestimate, since the number o f vehicles in the country i s not precisely known. 356. Inaddition, user charges such as annualvehicle license fee andvehicle import tax are relatively low. The annual vehicle license fee i s only about US$8 for small passenger cars and the import tax is only 10 percent. According to a 2001 report,lo8 the level o f these two taxes i s 6 to 10 times higher in countries o f similar GNP per capita (although the difference i s much smaller ifthe 20 percent VAT i s added). The level o f motorization in the Kyrgyz Republic is, however, very high compared with that o f other countries given the population's income level; thus, it does offer a potential tax base. For instance, Table 8.7 shows more vehicles per person in the Kyrgyz Republic than in Georgia, although the per capita GDP i s less than half that o f Georgia. Thus, there i s some room to increase the collection rate o f taxes on fuel and vehicles under the existing law and also to gradually increase the low rates of these taxes. Although the point has beenmade IO8G.Metschies, "Financing UrbanRoadsinKyrgystan," May25,2001 (financed by GTZ). 125 before, the political will to address the matter seems to be lacking at this point. The State Customs Committee has recently made efforts to understand the problem o f the smugglingo foil products, but a clear anti-smuggling strategy is yet to be defined. 3. Operations 357. Good progress has been made inreducing the role o f the government intransport operations. Although the former state-run enterprises are still mostly joint-stock companies owned by the government, they operate on commercial principles. Freight transport has generally been fully liberalized, but the government still closely controls passenger transport. Since transport demand has fallen off drastically over the last decade, most joint-stock companies are overstaffed despite substantial retrenchment. Redundancy packages should be considered to assist enterprises inreducing staff. This i s valid also for the railways and the national airline. Equipmenti s grossly over-aged and i s costly to operate and maintain. For these two reasons, operating costs are higher than they could be under fully commercial operation. Consolidation can be expected among the joint-stock companies and failures among the private companies. 358. Difficult social choices exist in terms of both reducing employment in the transport companies and raising fares charged to passengers so that transport companies can survive financially. The government imposes public service obligations (PSOs) on the passenger services o f road and air transport companies. Not only are tariffs fixed by the Anti-Monopoly Commission, butthere are many classes ofpassengers who are either fully or partially exempt from payment o f fares. The losses incurred by these transport companies are only partially compensated by the government. As a result, these companies cannot renew their equipment and are gradually going bankrupt. 359. To improve the situation, the government should take the following steps: Review the level and quantity o f public services that it requires the transport companies to provide, with a view to gradually reducing the privileges and compensating the truly needy passengers through other means than low fares for everyone Define and agree on, in negotiation with the enterprises, a reasonable cost (based on increased efficiency in the enterprises' operations) for the newly defined PSOs that would enable companies to fully cover operating costs and gradually renew their equipment Compensate financially the companies for the difference betweenthe agreed cost of PSOs and the imposed tariffs. 360. For all other services, which are not directly o f a social nature, the government should allow the transport enterprises to set their tariffs freely. 126 Table 8.8: Kyrgyz Republic: Freight and Passenger Transport, 1990-2001 1990 1996 1997 1998 1999 2000 2001 2001 FREIGHT In% Thousand tons Rail 1,331 1,510 1,445 1,079 979 862 3.25 Road 33,900 34,400 34,200 35,000 25,000 25,034 94.38 Pipe1ine 470 600 591 2.23 Water 32 10 31 46 35 36 0.14 Air 8 11 10 7 3 2 0.01 Total 35,271 35,931 35,686 36,602 26,617 26,525 100.00 Milliontkm Rail 2,620 481 472 466 354 338 332 18.99 Road 5,63 1 888 1,253 1,015 ,125 1,200 1,077 61.61 Pipeline 232 292 292 16.70 Water 6 2 6 8 6 6 0.34 Air 372 102 97 87 68 56 41 2.35 Total 8,623 1,477 1,824 1,574 ,787 1,892 1,748 100.00 Average Dist.(km) Rail 361 3 13 322 328 345 385 Road 26 36 30 32 48 43 Pipeline 494 487 494 Water 188 200 194 174 171 167 Air 12,750 8,818 8,700 9,714 18,667 20,500 PASSENGER 000 passengers Rail 1,040 1,004 635 445 589 642 0.13 Bus 254,800 306,300 360,300 351,000 393,000 416,314 86.04 Trolleybus 56,000 66,000 66,300 60,500 66,400 63,294 13.08 Taxi 4,600 4,900 6,100 3,000 2,500 3,421 0.71 Air 559 465 432 312 273 197 0.04 Total 316,999 378,669 433,767 415,257 462,762 483,868 100.00 Millionpkm Rail 205 92 93 59 31 44 49 0.90 Bus 5,501 2,494 3,022 3,646 3,881 4,326 4,712 86.33 Trolleybus 182 213 216 197 272 259 4.75 Taxi 41 53 52 34 24 57 1.04 Air 3,818 869 685 604 532 519 381 6.98 Total 9,524 3,678 4,066 4,577 4,675 5,185 5,458 100.00 Average Dist. (km) Rail 88 93 93 70 75 76 Bus 10 10 10 11 11 11 Trolleybus 3 3 3 3 4 4 Taxi 9 11 9 11 10 17 Air 1,555 1,473 1,398 1,705 1,901 1,934 Source: Ministryo f Transport, May 2002. 127 Figure 8.1: KyrgyzRepublic: Ministryof Transport HeadquartersOrganization Chart 1 Minister I Communications 1 Minister Minister and Information n Administration ~ Roads Economics Technical and Planning Personal, Legal Policy, and Control of Civil Implementation Financial, External Accounting and Relations t Control Source: Ministryo f Transport, May 2002. 128 Figure8.2: Kyrgyz RepublicMinistry of TransportOperatingDepartments MINISTRY OF TRANSPORT AND COMMUNICATIONS Railway Operation PLUADS (Oblast Department road Maintenance Districts) Intercity Bus Stations Road Design Institute space control AIR NAVIGATION KYRGYZ POST OshRepair Plant .-I I Railway Constriction International I Auto Transport Enterprises including Osh Trolleybus Company Source: MinistryofTransport, May 2002. 129 9. AGRICULTURE AND IRRIGATION A. BACKGROUND 361. Agriculture i s the dominant component of the Kyrgyz economy, accounting for 47 percent o f GDP in 2001. Its impact i s even greater if services and manufacturing activities that are closely related to agriculture (e.g., the food industry) are taken into account. Owing largely to strong reform efforts, agriculture has made a relatively better recovery than the rest o f the economy, particularly primary production. 362. These reforms have included price liberalization, a land and agrarian reform process, the phasing out o f direct budgetary support to state farms, the breakup o f the bread complex and other monopolies, and efforts to encourage micro-credits and extension services for farmers. The impressive pace o f the establishment of new private farms-driven by the agrarian reform-illustrates the scale o f changes in the system. At present there are more than 60,000 single and multiple-family farms, averaging about 20 ha per farm, that have been created from about 500 collective or state farms from the Soviet era with an average o f more than 2,500 ha per farm. 363. Agribusiness,on the other hand, has undergone an expected contraction, as some old agribusinesses were no longer sustainable and were appropriately dismantled. This appliedparticularly to meat and canning processors that formerly servedthe entire Soviet Union market, as well as the textiles industry. With the realigning o f prices with world prices, and with the competition for FSU markets coming from elsewhere around the world, these industrieswere uncompetitive on their previous scale. 364. Given the progress made inimplementingreforms, it i s appropriate at this stage to review whether the budget, including both funding and institutions, has kept pace with this restructuring and reflects the appropriate priorities for setting the principlesfor the market economy that the authorities have been pursuing. While granting that the transition o f KR from being an appendage o f Soviet Union to an independent market economy i s still not complete, a PER will help in assessing progress made thus far. In assessingprogress, one has to recognize the limitedpolicy and implementation capability in KR Government-issues that were analyzed in the first four chapters o f this report. With this background in view, this chapter describes the size and composition o f public expenditure in agriculture and irrigation, and assesses their consistency with sectoral objectives and strategies, and also assesses whether the composition o f the expenditure i s balanced and efficient. B. PUBLIC EXPENDITURE AGRICULTUREAND IRRIGATION IN 1. Trends and Issues in Spending 365. Public expenditure inagriculture fell sharply between 1991 and 1994, from about 18 percent to 2 percent o f the total budget allocation (see Table 9.1). Such a sharp 130 reduction was certainly necessary, as spending in the early 1990s was heavily biased toward the subsidization of production rather than the indirect support and facilitation that a vibrant private sector would need from government. Spending in the sector began to recover in 1996, mainly owing to strong donor support (PIP and non-PIP) to the government's programs, and by 2001 sectoral spending represented about 7 percent of total expenditures.Inthe aggregate, this level of spending appears adequate.lo9 Table 9.1: Evolution of Public Expenditure(Actuals) in Agriculture, Water Supply Organizations, Forestry,Fishing, and Hunting, 1990-2001 1990 1991 1992 1993 1994 1995 1% 1997 1998 1999 2000 Mol InMillionsom Agricultureanduata 3 3 24 118 86 149 165 242 474 747 1116 1322 Domesticb wofdich 3 3 24 118 86 149 165 216 324 3% 576 907 Eusupport(MinislyofAgricultureonly) 0 0 0 0 160 114 95 282 194 PublicInvshnmtRopm(RF')li 0 0 0 0 na n a 1 26 149 417 672 752 m: supp~rt(EvandPlP)asshareoftotal aid 7% 56% 69% 85% 72% As ShareofTotalExpenditure Agncultureanduata 17.5 9.3 9.1 7.4 2.2 2.6 2.4 2.7 4.3 4.8 6.2 6.8 Domesticbudget 17.5 9.3 9.1 7.4 2.2 2.6 2.4 2.4 3.0 2.6 3.2 4.6 PublichvshnmtProgram 0.0 0.0 0.0 0.0 n a na 0.0 0.3 1.4 2.7 3.7 3.8 m:Domesticasshareoftotaldomestid 17.5 9.3 9.1 7.4 2.2 2.6 2.7 2.7 3.6 3.5 4.2 5.5 m:AgriculturePIPasshareoftotalPIP 0.1 2.7 7.6 10.2 15.0 24.0 As shareof GDP 6.6 2.9 3.3 2.2 0.7 0.9 0.7 0.8 1.4 1.5 1.7 1.8 6.6 2.9 3.3 2 2 0.7 0.9 0.7 0.7 0.9 0.8 0.9 1.2 Public Program 0.0 0.0 0.0 0.0 n a na 0.0 0.1 0.4 0.7 0.8 0.6 liIncludesforeignfinancingonly.Counterpartfundsarepartofdomesticspending. Note 1: Datado not includenet lendingfrom the budgetto state farms or enterprisesin the sector, a practice that was fully phasedout around 1997. Note 2: Data do not includedonor support to the sector outside o f the budget framework, such as the grants providedfor procurement of tractors or other commodities. Two features canbe highlighted regarding the most recent spendingpatterns: > Spending is highly biased toward investments. Over the past few years, there has been a strong bias in agricultural spending in favor o f investments."' This may have been an informed choice made by the authorities (rather than a push from the donors) as substantial catching up was needed to rehabilitate the irrigation infrastructure. However, a lack of recurrent spending would undermine the sustainability ofthese investments. ~~ IO9 According to one source the average share of spending in agriculture for developing countries during 1985-90 was about 7 percent (Sanjay Pradhan, Evahating Public Spending: A Framework for Public Expenditure Reviews, May 1996). According to another source the average for 40 developing countries for the period 1982-89 was 7.2 percent and for 15 industrial countries it was 3.8 percent (Balcrom, Knudsen and Nash, The Reform of Public Expenditures for Agriculture, World Bank Discussion Paper # 216, October 1993). Also, agriculture's share in total expenditure should be compared with other FSU countries-Armenia (6.6 percent), Azerbaijan (4.4 percent), Tajikistan (3.3 percent), and Kazakhstan (1.6 percent). 'lo Although as suggested in Annex 10.1, there are substantial data problems, including the fact that PIP spending is not classified carefully enough to be able to differentiate that part of it that is actually recurrent spending. 131 > Spending relies heavily on donor funding. Since 1997, almost 70 percent of the funds available to the sector have come from donors. Inparticular, the European Commission has been supporting recurrent expenditures (other than salaries) while other donors, including the ADB and the World Bank, have beenfinancing investments. 366. Both o f these features raise issues o f ownership, sustainability, and, of course, inflexibility inbudget management. Regarding inflexibility, ifproject finance is tied to a particular set of activities, it becomes difficult for the fiscal or agricultural authorities to "control" the process of reallocating resources in accordance with priorities within the sector and across sectors. This can be avoided if the Government and donors agree on appropriate financing priorities before expenditures are incurred. Table 9.2 gives the annual level o f expenditure o f the recurrent budget for agriculture and irrigation and the support provided by EU through its Food Security Program. EU support to recurrent expenditure helps the Government to use its own resources on high priority items. Here sustainability becomes a major issue. Table 9.2: Extent of European Union Support for the Agriculture and Irrigation Current Budget, 1997-2001 (million som) 1997 1998 1999 2000 2001 MAWR excl. irrigation 53 90.2 87 96.2 117.4 EUsupport 38 66.7 59.1 78.2 94.8 Percentage o f EU support 71.7 73.9 67.9 81.3 80.7 Dept. Water Resources 66.7 153 199.8 165.7 195.2 EUsupport 17.8 95.9 88.8 112.7 130.4 Percentageof EU support 26.7 62.7 44.4 68.0 66.8 Source:EU. 367. A concerted effort on the part o f donors and the government would be neededto shift the focus from the investment budget to the recurrent budget over time, and to reduce the extensive donor dependency. Clearly, the direction i s for donors to tie substantially less of their funding to particular spending items (whether through project finance or cash support) and to move toward supporting an overall budget framework. This, o f course, presupposes that the Government would have policy and implementation capacity. At present, this capacity i s extremely weak, as previous chapters analyzed. With the strengtheningo f this capacity, donor support could focus more on supporting overall budgetframework rather than financing specific items. 132 2. Compositionof the DomesticBudget"' 368. With limited resources available outside o f the projects, the government (and the EU)mustmakeconsiderable efforts to prioritize and support market structures. As shown in Table 9.3, the domestic spending of the central Ministry of Agriculture and Water Resources (MAWR) focuses on activities related to water, livestock, crop production and crop protection, and land and agrarian reform. The main point i s that each o f these expenditures i s very small (smaller than they appear to be in Table 9.3, which includes counterpart funds for projects) butthey do appear to reflect the appropriate functions. 369. The functional review o f MAWR, carried out under an EU technical assistance program, shows that there are 21 subdivisions o f the Ministry-some called Departments and some called Directorates. The functions they perform can be grouped under four major functions, and their indicative shares o f expenditure at present, based on the review for 2001, are as follows: (i) policymaking (2 percent); (ii) regulatory (13 percent); (111 direct service delivery (65 percent); and (iv) supervision and management (20 percent)." "'2 370. A quick comparison with the pattern of expenditures o f other countries such as Pakistan shows that the Kyrgyz Republic spends significantly more on service delivery functions than Pakistan. This i s somewhat expected because the private sector has not yet developed well and the Soviet legacy o fpublic sector has lingeredon. Table 9.3: Domestic Spending by MAWR by Departments, 1997-2001 Ministry ofAgriculture and Water Resources (MAWR) Total Agriculture Land and Livestock Crop Other Total Irrigation Total w.0, PIP w, PIP memo Agrarian Production W.O. Agro Dept. MAWR US mln Reform & protection Water w. PIP million som 1997 3 17 10 2 31 97 161 238 264 15 1998 9 36 22 8 75 129 245 350 470 23 1999 6 30 28 9 73 149 261 360 777 20 2000 7 43 28 11 90 172 316 476 1148 24 2001 5 36 23 18 81 189 335 608 1361 28 in percent of GDP 1997 0.008 0.054 0.033 0,005 0.100 0.315 0.525 0.777 0.861 1998 0.028 0.105 0.063 0.022 0.218 0.378 0.718 1.025 1.374 1999 0,011 0.061 0.057 0.019 0.149 0.305 0.535 0.739 1.594 2000 0,011 0.065 0.043 0.018 0.137 0.264 0.484 0.729 1.756 2001 0.007 0.048 0.031 0.025 0.110 0.256 0.454 0.823 1.841 Source: MAWR. MoF and WB staff calculations. Note: Total Expenditure includesexpenditureby all agencies of government in agriculture ' I 1Domestic spending includes recurrent spending and counterpartfunds for projects. Some of these items are agreedwiththe EUpriorto receivingtheir grant. 'I2 This categorization differs slightly from the functional review carried out by the EU, which uses five categories. This paper collapses the last two related EU categories into one. The notional shares of expenditures for the four categoriesare based on estimates by EUreview and examination ofthe functions o f personnel in administration which help to attribute a part o f the service delivery expenditures to supervisionand management. 133 371. Within domestic spending, it i s useful to look at the breakdown by type of expense (Table 9.4). For non-water recurrent expenditure, the proportion of recurrent expenditure spent on wages and salaries varied from 47 percent to 30 percent. This compares well with aggregatedwage expenditures in other developing countries, which 'wasabout32percentduring 1985-90(Pradhan, 1996).Comparativelyfar fewerresources went for capital repairs inthe agriculture sector inthe Kyrgyz Republic.Infact, the share of capital repairs has actually declined since 1999. The share of other operational expenses (which includedtransport, equipment,travel, etc.) varied from 37 to 55 percent. 372. A look at the economic composition of current expenditures on irrigation (Table 9.4) shows that more was spent on capital repairs during 1997-2000. After 2000 this amount declined sharply, but operational expenses increased. As discussed later, far less has been spent over all than the amount neededto keepthe entire systemgoing. Table 9.4: EconomicCompositionof Total Expenditure, 1997-2000 (in percent) 1997 1998 1999 2000 2001 Total Agriculture Wages & salaries 47 30 36 35 35 Capital repairs 16 16 17 10 10 Other op. expenses 37 54 47 55 55 Total 100 100 100 100 100 Irrigation Wages and salaries 49 26 32 28 35 Capital repairs 30 37 33 22 negligible Other op. expenses 21 37 35 50 65 Total 100 100 100 100 100 Inves. ExpDom. Exp. (%) 159 168 137 142 184 Source: Based on Annex Tables. 373. Finally, Table 9.5 illustrates the relatively little progress made toward decentralization of spending inthe Kyrgyz Republic,at least on the agricultural side. The local governments are expected to have a role in agriculture and irrigation (for example, in coordinating activities of WUAs and levying and collecting irrigation service fees). Apparently the local bodies have taken on that role as yet. Another surprising feature i s the low reliance on special funds (which would include irrigation service fees), which reflects the extra-budgetary revenues of budget institutions left at their disposal for use. Table 9.5 shows very little contribution of special funds, which perhaps reflects mainly low level of irrigation fees. 134 Table 9.5: Economic Composition of Total Expenditure, 1999-2001 1999 actual 2000 actual 2001 preliminary Yo GDP % GDP Yo GDP Total (incl. PIP) 1.6 1.8 2.0 Total (excl. PIP) 0.7 0.7 0.8 O.W. special funds 0.0 0.1 0.1 Republican 0.6 0.6 0.8 O.W. special funds 0.0 0.1 0.1 O.W. other 0.6 0.6 0.7 Local 0.1 0.1 0.0 O.W. special funds 0.0 0.0 0.0 PIP 0.9 1.o 1.2 Source: MoF, Treasury and PIP Departments, 3. CapitalSpending 374. As shown in Table 9.6, the share of agriculture development expenditure intotal development expenditure increased from 10 percent to 24 percent between 1999 and 2001. The rehabilitation o f irrigation and other rural infrastructure has figured most prominently in the development budget. Rural finance agricultural support services are next in importance. In later years this type of expenditure includes support for an agricultural development bank and small amounts for credit unions. While irrigation i s a public good, particularly in large channels and dams, investment in rural financial services can only be justified as a transitional arrangement while financial sectors emerge, and at present only requires the clear formulation of an "exit" strategy. 135 Table 9.6: Public InvestmentProgramin Agriculture (In million som) Ag Domestic Foreign Share of Foreign Finance Finance Total Total Share (%) 1997 TotalAgriculture 24.4 283.6 307.9 16% 92 Ag. Support Services 12.2 12.2 100 Ruralfinancial Services 5.2 167.1 172.3 96 Improvementof Irrigation 15.7 53.9 69.6 78 1998 TotalAgriculture 25 488.8 513.8 12% 95 Ag. SupportServices 2.1 41.6 43.7 95 Ruralfinancial Services 0 320.3 320.3 100 Improvementof Irrigation 16.6 64.5 81.1 80 1999 TotalAgriculture 46.4 417.7 463.1 10.3 90 Support of Ag. Services 5.1 53.7 58.8 1.3 91 Rehabof Irrigation 35 173.4 208.4 4.6 80 RuralFinance 0 134.2 134.2 3 100 2ooo TotalAgriculture 30.5 671.6 702.1 14.6 96 Supporto fAg Services 6.4 182.6 188.9 3.9 96 Irrigation 18.2 172.9 191.1 3.9 90 Ag., Ag. Financial Services 0 144.6 144.6 3.O 100 2001 TotalAgriculture 144.2 752.5 896.7 24.4 94 Support of Ag. Services 3.5 86.7 90.2 2.5 96 Irrigation 20.9 196.4 216.3 5.9 91 Aral Project 2.9 10.7 13.6 0.4 78 Ag., Ag. Financial Services 88.8 211.9 300.7 9.2 71) . - 375. Donor support is most pronounced in the development budget. Overall donor funding of the development budget varied from 90 to 96 percent, raising a serious question of the sustainability o f investment inthe mediumto long term. At this stage, the rehabilitation of infrastructure-especially of irrigation-is o f paramount importance to the sector andthe donor agencies, includingthe World Bank, are rightly focusing on this. However, as is discussed later, it i s still a matter of concern as to how much support will be available inthe future. It is critically important to have a clear strategy on irrigation, one that indicates what should be rehabilitated and how the irrigation infrastructure will be maintained, with increasing responsibility assumedby beneficiaries. As noted later, an irrigation framework paper has already been prepared and could be developed into a muchneededstrategy for irrigation development andmaintenanceinthe future. 376. The availability of counterpart funds for donor projects has become a serious problem. The under-provisioning of counterpart finds causes delays in the 136 implementation o f investment projects and has thus become a source o f expenditure arrears. Inaddition, the counterpart funds that are allocated are often not released fully or on time. This is yet another symptom that the amount o f donor dependence has become unsustainable. In particular, it shows that a point has been reached at which allocating counterpart funding for projects demands cuts in that part o f the domestic budget that i s unrelated to projects. The release o f funds in relation to planned funding during the period i s shown inTable 9.7. Table 9.7: Planned and Actual Releaseof Funds to Investment Projects, 1999-2001 (in million som) 1999 2000 2001 Budget Allocation 1070 812 1015 Actual Releaseo f Funds 463 702 897 Actual Plan ("h) 43.2 86.4 88.4 377. Looking ahead, there i s a real need to substantially prioritize project-finance interventions in the agricultural sector. As explained below, key rehabilitation must proceed (but some downsizing o f the overall amount o f planned rehabilitation may well be warranted). At the same time, projects that open the way for the future institutions for water management must be encouraged (ifthey are already inplace) or developed (ifthey are not yet in place) (see Section C. 3). Room can also be created in the budget for priority interventions by phasing out unnecessary off-budget operations (Section (2.4). 378. A more immediate need i s for appropriate budgeting. Despite commitments made by the government, the MoF has repeatedly failed to release counterpart funds for projects, reflecting a bias toward overestimating its capacity to provide funds. Evenifthe total amount o f project implementation i s reduced, it i s fundamental that the quality o f the implementation-including the timely availability o f counterpart funds-must improve. The effect o f this poor planning o f funding i s that suppliers, contractors, and consultants do not receive the full payment due them for extended periods o f time (e.g., arrears buildup). C. KEYISSUES 379. The major issues emerging out o f the review are: (i)the under-funding of extension, research, and to some extent land reform; (ii)the critical challenges o f irrigation maintenance; (iii) duplicating and overlapping public institutions inagriculture; and (iv) consistency with sector goals and expectations about the role o f government. These issues are dealt with inthe following sections. 1. Under-fundingof Key Functions 380. Extension. For a considerable period o f time after the breakup o f the Soviet Union, the Kyrgyz Republic did not have an effective institution responsible for extension (Le., knowledge and knowledge dissemination relevant to agricultural producers). Although some officials still work at oblast and rayon levels-officials who are supposed to disseminate know-how to farmers, but their know-how i s from Soviet 137 days and i s not very helpful. Extension can be considered both a public and a private good, depending on the specific application o f the information. Information which can be used by all without reducing its availability for any one individual can be considered a public good. Although most o f the extension work o f agents may fall inthe private good category, public sector services are justified in the case o f a developing or transition economies because, inter alia, benefits are diffuse, other public policies do not encourage private sector participation inknowledge sharing, and economic equity is a key goal. 381. However, public financing for extension services can be justified in the Kyrgyz Republic only for the smallholders, complementing the extension services provided by private sector, which i s likely to focus on (or to actually consist of) large farms. In its awareness o f these needs, the government started a Rural Advisory Service (RAS) with support from the Swiss Development Corporation, the World Bank, and IFAD. Decentralized, demand-driven extension services are the key elements o f RAS. However, the allocation in the current budget for extension is close to zero. The present effort is totally donor funded, and even the counterpart funds to be made available from the budgethave not come forth. The sustainability of RAS is, therefore, a serious issue. 382. RAS, which also includes its methodology center, Agriculture Training Center (ATC), offers such activities as training for farmers in topics o f interest, adaptive research group formation, individual and group consultation, exposure and campaigns. R A S has about120 field agents and 25 or so subject matter specialists workers. Their work i s overseen by 28 advisers4 per oblast. There are currently 7 expatriate advisers working at the central and oblast levels. The RADS work i s overseen by a national and seven oblast boards that include farmers. The expenses o f RADS for the period 1999 to 2001 are noted inTable 9.8. Table 9.8: Expenditureon RADS, 1999-2001 Indicatorsfyears 1999 2000 2001 Total budget (OOO$) 1,071.40 1,118.30 606.8 Total expenses (OOO$) 449.3 611.7 479.1 Percentageof utilization 42% 55% 72% No, of RADSemployees 155 166 100 Cost per employee($) 2,899 3,684 3,308 Cost per 1 client contact ($) 7.7 8.4 7.9 Source: Annual Report for January-December 2001 of Rural Advisory DevelopmentservicesFoundation. 383. Research. Agricultural research is another area that appears under-funded. However, unlike extension, the institutional setup for research has not been sufficiently modified to warrant an increase in the budget in the immediate term. Recent progress, however, i s encouraging. 384. Expenditure on agricultural research has been made outside o f the MAWR budget, but was part of the government's support to the Agrarian Academy of Science. Recently the research institutes were placed under MAWR, while tertiary education in 138 the Agriculture university was placed under the Ministry o f Education. Research organizations have also been reorganized recently by amalgamating three previous institutes dealing with livestock, veterinary services, and pastures and fodder into one, and two institutes dealing with soil and crops into one. The third and fourth institutes deal with irrigation and farm economics, respectively. Table 9.9 gives the budget allocation and actual release o f funds to agricultural research institutes for the period 1995-2001. Table 9.9: ResearchExpenditureby Institute, 1995-2001 (in 000 som) Nameof institutes 1995 1996 1997 1998 1999 2000 2001 KyrgyzAgrarian Academy 305.4 293.5 334.7 340.6 337.1 251.3 171.9 ResearchInstitute o fLivestock 875.8 1,079.6 1,351.3 1,095.6 1,386.9 1,230 1,719.5 ResearchInst.o f Veterinary 760.4 545.1 1,813.9 1,650.2 1,606 1,782.8 1,973 Res. Inst.of Pasture & Forage 514.7 432.9 847.1 655.4 782.4 641.7 778 IrrigationResearch Institute 382.4 352 525.7 526.3 643.5 530.6 619.8 Res. Inst. of Land Farming 15,881.1 1,372.2 2,078.4 2,000.7 2,074.9 2,112.7 2,080 Res. Inst.of Soil Science & Agro Chemistry 320.8 309.5 382.6 362.5 414.2 351.6 386 385. The total expenditure on agriculture research (in current constant terms) and the percentage share o f agriculture research o f total current expenditure during 1997-2001 are shown inTable 9.10. Table 9.10: Total ResearchExpenditureand Share TotalResearch(current prices) 7,333.7 6,631.3 7,245.0 6,900.7 7,728.2 TotalResearch(1997 prices) 7,333.7 6,001.2 4,826.8 3,872.4 4,056.8 Total Ag. (current prices) 194,317 305,925 336,754 494,815 486,946 ResearchShare ("76) 3.77 2.16 2.15 1.39 1.58 386. Total expenditure on agricultural research has been falling in constant terms, and as a percentage o f total expenditure. The share has now moved lower than that found in other countries such as India, Pakistan, and Bangladesh (about 2 percent). While a reduction in budget allocation was needed to avoid inefficient spending on obsolete methods and institutions o f research (as was done in the past), it appears that recent changes merit support. 387. However, further changes are needed in the approach to research, and thus any higher spendingmust be tied to reforms. Agricultural research can be classified as basic, strategic, applied, or adaptive. Strategic and basic research, which expands the foundation o f knowledge, can be viewed as a public good and can be supported by the public sector in many countries. However, a country such as the Kyrgyz Republic should not be heavily involved in basic and strategic research. Instead, efforts must be made to 139 facilitate the dissemination o f basic and strategic research from other providers to interested parties through modernelectronic means (web sites, journals, etc.). 388. Adaptive and applied research i s more relevant. Given that applied and adaptive research carries commercial applications, the private sector would be interested in such research and the public sector may not need to be involved. However, in developing countries the private sector has little involvement in research, which i s why the public sector may play a role until the private sector steps in.Insome middle-income countries, private sector involvement i s growing. For example, in Thailand and the Philippines private sector agriculture research accounts for nearly 40 percent o ftotal research. 389. Property Rights. There are other areas inwhich an increased expenditure by the Government would help in strengtheningmarket institutions. For example, there i s a need to consolidate progress made thus far and proceed further in establishing individual property rights to land. Here there i s some underfunding. Given that this i s an area in which the Kyrgyz Republic has moved strongly inboth policies and institutions the land reform program, which has generally progressed well, must be adequately funded to generate farm structures that will meet the individual preferences and requirements of a market-based production system. No land reform program will be fully successful and effective unless individual owners know their rights and can effectively exercise them. 390. InTable 9.3, it canbe seenthat spendingdirectly on landand agrarian reform has been small-like that on other components-but also very volatile. For lack o f adequate funding, the work program o f the republican Center for Land and Agrarian Reform (RCLAR), including the program for public awareness, has not progressed as well as it could have, according to one recent Bank report. Consequently, there have beeninstances o f abuse o f or misinformation about the land reform process-instances that could have been avoided to some extent by full funding o f the reform program. It i s therefore recommended that the funding for land reform agencies be put on a more secure footing, one that would allow a sustained investment in building a market for land. In this connection, spendingon the creation o f a cadastre system shouldhave highpriority. 2. CriticalChallenges of Maintaining the Irrigation and Drainage (I&D) Infrastructure 391. The total arable irrigated land in the Kyrgyz Republic is around 900,000 ha. The O&M o f the irrigation infrastructure broadly consists of two kinds o f expenditure- maintenance o f head works and the (off-farm) main canal system and maintenance of on- farm infrastructure. Inaddition, a good part o fthe infrastructure has fallen into disrepair, although the essential pieces are being rehabilitated with donor support. 392,Current Approach. The current approach, as presented in a recent background paper submittedto the authorities,' l3 consists o f two important elements: At this pointthe paper is still ina draft form not suitable for quotation. 140 > On financing, it i s expected that over the medium to long term, all O&M costs o f large infrastructure will be borne by farmers. In this respect, it i s expected that over a period o f years the government will step up O&M spending, but will also raise irrigation fees. At some point inthe future (point X), irrigation fees will gain importance as a fundingmechanism, which will allow the government to direct its O&M spending to certain areas. While the government may still remain involved in0 7 M o fthe whole system, it will be able to primarily focus on the O&M for a reduced area, (for example, about 200,000 ha) which i s to be selected on the basis of social need(i.e., to the poorest regions). > Onmanagement, it is expected that the role o fthe government indeliveringO&M i s to be limited. In this regard, efforts are being made to organize farmers into Water User Associations (WUAs). The central government (and perhaps also oblast level governments) would play a mainly regulatory role, not only in laying out the rules o f the game for the WUAs and communities, but also inmonitoring the use o f water resources. Water use will be regulated through licensing abstraction and return flows, based on an assessment o f the overall demands for, and availability of, the water resources, and through maintaining and enforcing environmental protection standards. The government will also play a role interms o f providing assistance o f last resort, mainly to communities in need. Parallel to an increased responsibility for I&D infrastructure, farmers (WUAs) are also expected to acquire ownership (or concession) rights. Inparticular, full or partial privatization (or concession) o f the operation of distribution channels i s expected-which will require local government and raidvodhoz to relinquishtheir de facto control over these activities. Finally, the government will negotiate all water issues with neighboring countries. 393. CriticalIssues of Maintenance.Analysis o f the irrigation PER indicates that the expenditures are makingadjustments in line with the changes inthe institutions. After the end ofthe Soviet era, the bulk o fthe irrigation structure remained withthe Departmento f Water Resources (DWR) (a part o f the Ministry o f Agriculture). With the change in the system o f land holding (the emergence o f a large number o f smallholders which have replaced all but a few collective and state farms) and the formation o f the WUAs, which will take some O&M responsibilities, changes can be expected inthe size and nature o f public expenditure on irrigation. At present, there are 55 legally registered WUAs and around 153 informal ones. Much more progress i s needed informing user associations as well as inhaving these associations take on more maintenance responsibilities. Even with good progress in this area, irrigation maintenance would require some continued donor support. 394. A review o f the sources of funds for the Department o f Water Resources (DWR) shows that roughly only one-fifth o f the expenditures come from the national budget (Ministry o fFinance), and roughly 60 percent come from grants from the EU.Only about 20 percent o f the costs are met by water charges. As for the expenditure pattern, salaries and social funds account for about 28 percent o f the total budget. Rehabilitation work accounts for about 33 percent. 141 395. The Kyrgyz Republic depends on irrigation because rainfall is generally inadequate to support anything other thanextensive subsistence cultivation of a few drought-resistant crops. While irrigation is essential to agriculture, it seems expensive relative to other aspects of the cropping system. It should also be noted that a part of the high cost i s due to technical inefficiency arising from factors such as poor design, inadequate maintenance in the past (which now requires upfront huge cost), and over aged infrastructure. Ifsome these problems were addressed and incentives were created for an efficient on-far water use, irrigationcost per unitof crop output may come down. 396. Since the country inherited a large irrigation system concurrently with a large fiscal adjustment, it is not surprising that the resources available for maintenance fell far below the required levels during the 1990s. As a result, the irrigation infrastructure has fallen into disrepair. During 1998, 1999, 2000, and 2001, the DWR received, respectively, US$7 million, US$3 million, US$3.5 million, and US$4 million from the state budget for O&M for the off-farm system. The dollar figures are meant to provide comparable figures betweenthe years and the figure show the decline in funds for O&M indollars since 1998.Expenditurein 1997prices wouldshowasimilarly declining trend. 397. The other source for meeting O&M expenditure is the irrigation service fees collected from water users. The total proceeds remain limited because the fee remains low (15 som per 1000 m3until 1999 when it was increasedby Parliament to 30 som per 1000m3).The Ministry has on several occasionsproposedamendments to the Water Law to allow the government, and farmers, rather than Parliament, to set the level of irrigation fees, but this proposal has not been accepted. Collection i s made at the rayon level. Most rural areas are starved of cash and practice a barter economy. According to one estimate, up to 80 percent of the fee is paid in agricultural produce, which involves a heavy transaction cost. 398. That there has beena default inthe collection of irrigationfees is evident from the available figures for the substantial arrears to be collected. The total arrears to be collected at the end of 2001 would be over 65 million som. These are old arrears and clearly the WUAs are unable to pay such arrears. 399. The critical question is: what are the prospects for water charges for covering all the O&M costs of the head works and primaryhecondary canals? Estimates of the average cost of maintenance vary. According to one estimate, the cost of maintenance could be as high as US$25 per ha. The other estimates are lower, at about US$10 per ha. The estimates available for such countries as Turkey andMexico put the cost inthe range of US$15-US$20 per ha. Even if we assume the cost i s US$10 per ha (as in one of the recent Economic Reports), the total cost comes to about US$9 million (450 million som), which i s over twice the DWR budget in 2001. And this would be 10 times the irrigation fees, ifall the fees were collected. 400. Overall, calculations show that the DWR will not have sufficient funds under the present system to finance the O&M costs of head works and primaryhecondary canals. 142 Clearly, donor support will have to continue, or even increase, to enable the country to save the irrigation infrastructure. 401. The O&M results would by now be disastrousifroughly 60 percent ofthe budget did not come from the EU. At the same time, the World Bank and ADB have funded rehabilitation and some maintenance of the main channels through providing highly concessionalresources. The World Bank project alone put in 513 million som during the period 1999-2001. The government's counterpart funds for the same periodwere only 70 million som. 402. Regarding the prospect of collecting fees from farmers to rehabilitate and maintain the system, a recent project document presents calculations for two WUAs in Uzua-ky and Tolos Nankat. Assuming an average cost of US$lOO per ha for rehabilitation work and further assumingthat all incremental net returns for rehabilitation works could be available in cash to repay the costs, and that five years is a reasonable maximum period for all practical purposes, then in the case of Uzen Kyr, some 70 percent o f the works could be repaid over five years out of the incremental returns if the water charges remained at their present rate. With full water charges (meaning O&M cost plus part of rehabilitation costs) the Uzen Kyr WUA could not repay anything. For the other WUA (Tolos-Namkat), all the works could be repaid with the present water charges but only 33 percent with full charges. Based on these calculations, it can be concluded that farmers will not be in a position to bear the full cost of O&M and part of the rehabilitation cost. 403. To sum up, the total O&M requirement for the Kyrgyz Republic i s about US$9 million a year (450 million som) where the current budget allocation for irrigation is just over 200 million som, of which roughly one-sixth i s for O&M. In addition, the PIP allocation under all projects for irrigation is to the tune of 170 million som a year. In addition, if it can be assumedthat farmers will bear at least 25 percent o f the total cost of off-farm O&M (inaddition to bearing full on-farm O&M cost), the result i s a shortfall of roughly 140 million som in funding O&M alone. This underlines the need for continued or even increased donor support. As noted, this support is critical to enable the current system to provide opportunities to irrigators to adjust and move out of the uneconomic use of irrigation water and to move to better on-farm water management for productive, sustainableagriculture. 404. Key Challenges. Before there can be a full-fledged implementation of this strategy, financial headroom must be created in the budget. Clearly, the authorities through their PIP are already spending substantial resources on the rehabilitation of irrigation and drainage infrastructure. The most essential pieces of such rehabilitation must be completed at the utmost speed to create headroom for recurrent spending in the budget. 405. Greater effort is also needed to lay out a path for increasing water fees. While a new water code is been drafted that would shift the responsibility of setting fees (or fee policy) from Parliament to the government, it i s unclear whether Parliament would 143 approve it. A balance of trust will need to be struck between the government and Parliament, whichwould result inan acceptable approachto the fees. 406. Under the best of circumstances, however, it may be unrealistic to expect that point X in paragraph 409 will be reached in the very near future. This suggests that the government must step up O&M spending on irrigation over the next two to five years to avoid a potential social regressionandthe loss of today's investment^."^ 407. Prior to increasing financing, however, efforts must be made to redesign the manner in which funds are allocated. As WUAs are created, it could make sense to initiate a shift from funding the O&M work of the DWR to the provision of loans and grants to users, which would be based on a preference for lands with the highest economic internal rate of return(EIRR). As early as possible, the authorities could begin supporting disadvantaged areas by grants and loans held under an independent budget heading, with priority being given to assisting farmers who operate in disadvantaged areas and whose income is below the nationally declared poverty level. Inthis case, the idea would be to support farmers who individually or collectively cannot generate sufficient funds to keep the farm or WUA system functioning, as well as independent operators of supply canals and outfall drains that risk becoming inoperable. 408. Donors will play a key role over the next few years to the extent that the agricultural sector will remain highly subsidized, both directly through O&M and rehabilitation of the I&D infrastructure, and indirectly through lower taxation. Donor support for the current system is critical for providing opportunities to adjust and move out of the uneconomic use of irrigation water and move to better on-farm water management for productive, sustainable agriculture, the goal of the irrigation sector reform. 49. Donor funding of the resulting fiscal deficit, however, would be best provided inthe form of direct budget support-or support for the creation of key elements and institutions of the overall strategy, which should include the following objectives and actions (some of which have already started in line with a recent draft framework for irrigation strategy preparedwith support from the Bank). 0 The government will sustainthe irrigation and drainage system to allow irrigating farmers to make atransition where neededto a more productive cropping system. 0 The government will help inmakingthe transition to more productive, sustainable irrigationby promoting irrigation inareas where highvalue crops can be grown. 0 The government will not finance day-to-day O&M (particularly on-farm maintenance) and pay rehabilitation costs on a cost-sharing basis with farmer organizations. 0 Inthe mediumto long run, support for anuneconomic cropping system will have to be replacedby support for a switch to other economic activities. 'I4Irrigation inthe Kyrgyz Republic has been linkedto poverty reduction as it has helpedpoor farmers to become self-sustaining, at least partially 144 a The government will be responsible for ensuring the safety of major dams and reservoirs. a The government will transfer (through appropriate legislation) the ownership of distribution canals to non-government organizations including the federation of WUAs, when they are ready. a A decentralized system will be introducedinwhich the irrigation agency and later WUAs (when they are ready) will levy and collect irrigation fees without parliamentary control. a The government will monitor use of water and ifnecessaryregulate water use for environmental protection. a Some grant and loan schemes will be developed and implementedby the oblast governments (the key I&Dinfrastructure is basically inthree oblasts). 409. It should also be notedthat apart ofthe irrigationmaintenancecost would haveto be borne by neighboring countries that actually derive benefits from the system. A few examples of canal systems whose irrigation water i s designed to benefit neighboring countries are noted inTable 9.11. Table 9.11: Canal Systems in NeighboringCountries Share of Share of Neighboring KR Countries Isfara River 37% 63% SouthIrrigationalCanal 4% 96% SarainCanal 19% 81% Soh River 23% 77% Keridon 13% 87% Hodzha 21% 79% 3. Duplicatingand OverlappingPublic InstitutionsinAgriculture 410. There i s considerable duplication among different parts of the agricultural organization in providing services. For example, the activities of the State Veterinarian Department, the Central Republican State Veterinarian Laboratory, and the Elithe Joint Stock Company are similar and duplicative. Similarly, the activities of the Departmentof Chemicalization, the State Commission on Variety Testing, the Republican State Seed Inspectorate, and the Republican Center for Plant Protection Biological Means are also similar and overlapping. 411. The series (available in the annex tables) clearly shows that most of the recent expenditure went for salary and wages. Ifsome rationalization program ware carried out, there would be savings for operational expenses and the programs would be more effective. 145 412. Currently as many as eight subdivisions are engaged in regulatory functions. Their total expenditure has been in the region of 4 percent of the total current expenditure. There may be room for rationalizing the regulatory bodies and increasing their effectivenessby givingthemmore operational budgets. 413. There is duplication inpolicymaking functions as well. Infact, there is no single focal organization for formulating agricultural sector policies. MAWR has a policy unit that in some cases formulates policies. In recent years, the Secretariats o f the President and the Prime Minister have often led the formulation of agricultural policy, leaving MAWR on the sidelines. Although these Secretariats can provide leadership, staffs in these organizations often have less contact with and less detailed knowledge of agriculture and the activities of MAWR than the staff of MAWR. On the other hand, MAWR has shown weaknesses in formulating sectoral policy to serve sectoral interests and goals. It i s therefore important to establish a high-level policy cell within MAWR and to increase the total expenditure on policymaking functions from the present level, which is less than 2 percent. However, just raising the expenditure on the policy making function may not lead to satisfactory results unless measures are taken to improve and incentives for public employees, as outlined inprevious chapters. 4. Consistency with Sector Goals and the Expected Role of Government, and Key Issues in Market Economy 414. The key policy papers, including the interim National Strategy for Poverty Reduction (I-NSPR), articulate well a vision for the sector. However, more recently, the Director o f the Policy Department o f the Ministry of Agriculture presented a paper capturing the Ministry's vision about the role of the government in agriculture that indicates that the country i s committed to continue moving to a market system, but that also elaborates substantially on production, yields, and sowing targets. 415. The point to be made i s that the government's statements often suggest a central planning orientation in its approach to agricultural production. Such an orientation and emphasis clearly run counter to the goals of establishing a market-based system. Carefully formulating a strategy and vision for the agriculture sector (keeping inmindthe needs of a free market economy) and sharing the strategy and the vision widely with all concerned will be highly desirable. Some discussion, however, appears to be needed regarding the role of quantity targets for the sector, as well as such goals as self- sufficiency. 416. Taking the interimNSPR as the starting point, it is possible to assess consistency betweengoals and spending. Starting from that position, this review identifies some areas that show an overextendedrole of the public sector and under-funding of some functions. The rest of the section will focus on the overextended role of the government in input markets. 146 i. Input Markets 417. Fertilizers. Inresponse to a weak input supply, the government, often with donor support, has spent money directly on buying fertilizers, combines, and pesticides. Generally, the actual import has depended on the external financing available and therefore the qualities have often been far below what i s necessary to sustain modern agriculture. This direct interference in the input market has hampered the growth o f private trading inthese markets. 418. Because o f the continued role o f the government in fertilizers, not many private companies have emerged. Fertilizers also move through a network o f informal-illegal - traders. The input trade i s affected by a network o f the policies o f neighboring countries such as Uzbekistan. Since Uzbekistan subsidizes fertilizers, illegal imports from Uzbekistan are at present substantial. 419. Seeds. The government's role in the seed market may also be overextended. The Kyrgyz Republic's seed industry continues to operate largely according to the Soviet style, with different steps from research through sales assigned to different government organizations. Government research institutes are responsible for breeding, after which a government committee approves new varieties for seed multiplication and sale. Research institutes then deliver the required quantities o f breeders' seed to designated seed farms. Here there are even more steps, as seed farms are separated into tiers, and research institutes produce super elite seeds, passing these seeds on to designated farms to produce commercial seed for sale to farmers after at least two reproductions. Duringthe transition period, scientists and officials in the Ministry of Agriculture have not only continued the Soviet method but appear to have extended it through new regulations. In recent years, however, there have been some reforms in seed policy and practice to make the system more market based. Table 9.12 records the total expenditure on seed for the period 1997 to 2001. Table 9.12: Public Expenditureon Seed, 1997-2001 (thousandsom] 1997 1998 1999 2000 2001 All seed 3,483 13,386 13,098 20,545 7,24 1 functions Source: Calculated from Annex Tables. 420. The government expenditure on seedpeaked in2000 (20.5 million som) andwent down significantly in 2001. Such decline i s in keeping with the reformed role o f public sector in seed market. In addition to its direct involvement, the government exerts indirect control. Until 1999, the government, through the Land Distribution Fund, allocated almost 7 percent o f total arable land to the Agrarian Academy for farms to grow seed and for livestock. This operation has now been scaled down. 421, The continued involvement of the public sector in seed has adversely affected agricultural productivity. The inefficiency in the present system comes from the fact that the government does not allow seed sales until the government has approved the new 147 variety. With limited budgetary resources, and with the government meeting only the salary o f scientists (see the section on agricultural research), not much development o f new varieties is taking place. As a result, agricultural productivity is suffering and no technology transfer from abroad i s taking place. 422. Farm Machinery. The government has retained a considerable role inproviding farm machinery. In market economies, most farm machinery would be owned by individual owners. In the Kyrgyz Republic, there i s no restriction to private ownership and management o f farm machinery. But the government has retained its large role through setting up a new parastatal, Ailtechservice (the government owned joint-stock company). Ailtechservice uses government funds outside the budget (mainly grants) to acquire tractors and combines to lease out and also to employ on some government farms. As o f 2002, Ailtechservice has 19 regional offices and over 500 staff, and owns about 250 tractors and about 130 combines. There are 12 regional enterprises that form part o f Ailtechservice. 423. There i s also an implicit subsidization o f Ailtechservice to the extent that little o f the funds made available are actually repaid. While accounts for this company are difficult to obtain, the amount o f grant funding provides some indication o fthe degree of subsidization, which puts any private sector competitor at a disadvantage (Table 9.13). Table 9.13: Grants for Input Purchases Year Amount ($US) 1995 2.5 1996 8 1997 3.5 1998 3 1999 3 2000 3.3 200 1 3 Note: These grants are all implementedoutside the budget. Source:WB staff calculations. 424. For example, in 2001, Ailtechservice received 70 tractors whose market value was 140 million som, but it paid the government only 10 million som. This meant that the agency received a subsidy of 130 million som inthat year. The subsidy inother years will be a similar amount and will constitute 27 percent o f the total public expenditure in agriculture. According to the annual accounts report for 2001, Ailtechservice's liabilities exceeded its assets by more than 100 million som. In 2002, the government acquired 72 newBelarustractors on a barter deal, which Ailtechservice is going to receive for use and for leasing. 148 ii. OutputMarket 425. The government's interventioninthe output market, althoughvastly reduced from what it was inthe past, is still not negligible. The current intervention is at two levels- central government and local government. At the central government level, a state wheat reserve o f 1,000 tons i s being maintained. Currently, 60 percent o f the reserve i s meant for maintaining a strategic reserve and 40 percent for meeting food needs in the remote areas. 426. This wheat reserve system, managed by a parastatal called Kyrgyz Danazig but now under the Procurement Agency, has an annual budget o f 40-50 million som. However, according to a Treasury execution report, a sum o f 266.3 million was allocated to the parastatal. The plan for 2002 i s 42 million som. A part o f the support must have been provided through grant aid. Every year, 60-70 percent o f the wheat reserve i s replenished. One source o f replenishment i s food aid, which i s often negotiated and accepted without adequate attention to the consequences o f the aid deliveries on the domestic market and on incentives for the domestic growers. A part o f the wheat reserve i s used for the payment of budgetitems, such as "universal monthly benefits." 427. According to a recent Bank project supervision report, the local government authorities often exert an influence on the farmers to produce certain commodities, partly to fulfill indicative targets set up by the central government. And in some cases, the local governments enter into an agreement with foreign buyers to sell some products. The power that still exists to lease out some land allows these local bodies to influence production decisions. The local bodies exercise their power over the land retained inthe Land Distribution Fund. D. CONCLUSIONAND FUTURE AGENDA 428. The share o f agriculture inoverall public expenditure is at reasonable levels and is generally comparable with that o f other developing market economies where agriculture i s a key sector o f the economy. However, there i s room for improvement in the composition and efficiency o f public expenditures. To begin with, a strategy and vision for agriculture should be formulated and shared with all concerned. In particular, the strategy for irrigation should be further developed with a realistic outline of its timing and a clear path for its actions (such as a time-bound or an event-bound path for the introductiono f cost-recovery policies). 429. Consistent with market-based agriculture, the government needs to undertake a phased withdrawal from certain activities where the risk o f crowding out the private sector is severe, such as: 0 The continuing involvement in the input market, especially in renting out agricultural machinery and, to some extent, inseed multiplication 0 Wheat procurementactivities except for a strategic reserve. 149 430. Other major recommendations spring from the specific nature o f agricultural production in the Kyrgyz Republic, which i s heavily dependent on an irrigation system whose maintenance now imposes substantial "legacy costs" on a relatively poor country. The system i s being tolerably maintained, but only with the aid of a large amount o f donor funding. Evenwithin the development expenditure category, the needto maintain the large network o f physical capital makes it more difficult to invest invital intangible capital. Nonetheless, efforts must be made to increase support to such critical public good expenditure areas in agriculture as: (1) agriculture research, extension, and land titling; and (2) neededregulation and quality control activities. 431. Prior to any increase in funding, however, the research system needs to move away from the Soviet era structure and priorities to an emphasis on market-driven research. 432. As noted, in the Kyrgyz Republic, donor support for agriculture and irrigation is high.While support is very muchneededinthe short run,the size and composition o fthe donation should follow a strategy that ensures that donor dependency declines over time. In particular, the overextended role of the public sector should not be fostered or strengthened by the donor support. This applies to a larger extent to government involvement inthe input trade, to a lesser extent infinancial services, and to some extent inirrigation. 433. As already stated, irrigation will remain the single most dominant factor in agriculture expenditure decisions for the foreseeable fbture. Costs such as depreciation and environmental depletion will be incurred regardless of what the government does, and the best approach i s to have an explicit framework for managing and containing the costs o f the system. The rehabilitation and maintenance o f irrigation infrastructure inthe short run i s critically important for the purpose o f giving the farmers an opportunity to adjust to a more productive and sustainable cropping system. Some actions in irrigation are therefore urgently called for, such as developing an institution for a new role o f the government (more focused on regulation and financing o f last resort). 434. Some of these decisions clearly involve more general decisions about the future role and size o f irrigation-based agriculture inthe Kyrgyz Republic, and point once again to the need for a unified strategy for the sector and the integration o f such a strategy into the budgetingprocess. 150 References European Union, Functional Review of the Ministry of Agriculture Water and Agroprocessing, August 2001 Odin Knudsen et al., Redefiningthe Role of Government in Agriculture for the 1990s. World Bank DiscussionPaper #105, November 1990 Yusuf ChoudhuryandRashidFaruqee, PakistanPublicExpenditureinAgriculture, South Asia RegionalWorkingPaper Series, June 1995 World Bank, Kyrgyz Republic: Agriculture Agribusiness: GrowthOpportunitiesand Obstacles,July 2002 151 ANNEXES ANNEX 1: WAGESYSTEMS For governmentemployees funded(infull or inpart) from the budget Type of employeedorganization Who administers wage issues, and most recent major legislation/regulation Civil servants (according to President's Decreeas ofJanuary 4,2002 #3) Central level President'sadministration. President's Administration Special wage scale (Aug. I 2000) Office of Prime-Minister President's decree as of August 1,2000 Nr!196((Oncivil Parliament(apparatus staff) servants remunerationconditions" Election Commission Accounting Chamber (incl. territorial departments) Ministries,state committees, National Statistical Committee, National commissions, incl. their territorial departmentsand agencieddepartmentsunder ministries (like tadcustom inspections or financial police) Regional level President's administration. Oblast state administrations Special wage scale (Aug. 12000) Raion state administrations President's decree as of August 1,2000 Nr!199((On remunerationconditions for local authorities staff' Army, security.. . President's administration. Interior Special wage scale (Aug. I 2000) Defense 1. President's decree as ofAugust 1,2000 Ns!200 "Cash National Security Council. allowances for servicemenand employeesof interior" National Guard 2. President's decree as ofAugust 1,2000 Nr!198 "Salaries for State Guard Department(president's military and specialranks" guard) NBKR President's administration; Board chairman Special wage scale (Aug. I 2000) Deputy chairman President's decree as of August 1,2000 Nr!196 ((Oncivil Board members servants remunerationconditions" SocialFund President's administration; Board chairman Special wage scale (Aug. I 2000) Deputy chairman President's decree as of August 1,2000 Ns!196 ((Oncivil servants remunerationconditions" Budgetary employees (not categorized as civil servants) Budget sector Government; Health USR (Un$ed Scale of Rates/ TariffNet) Education GovernmentDecrees 225 (May 21, 1993) and 175 (March Science 3 1.1998 with amendments 2000,2002) Culture More detailed sectoralregulations approved by the MLSP Archives Collegium Decrees in 1993-1994years sport Hydrometeorology Vocation training Agriculture, irrigation, forestry Auxiliary staff Government; 153 Type of employeedorganization Who administers wage issues, and most recent major legislationhegulation Governmentdecree as o f December3 1,2001 N! 839 ((Remunerationconditionsfor employees servicingstate bodies, local authoritiesand self-government)) ProjectImplementationUnits(PIU) Government; GoscominvestDecreeas ofApril, 26,2000 Nc40 ((Salariesfor PIUstaff)) Social Fund Government; Regulation"About MHIF underMoHKR",approvedby Government's decree as o f February15, 1999 N! 83 Regulation"About EmploymentFund" approvedby Government's decree as of July 9, 1999 Nc 382 Regulation"About Social Fund", approvedby President's Decreeas ofApril 5,2001 Nc116 154 ANNEX 2: PAYAND EMPLOYMENT MODEL This annex presents several hypothetical scenarios of civil service pay and employment reform, using a model constructed by the World Bank. These scenarios are intended as specific policy proposals; indeed, some o f the scenarios may well be inadvisable. Rather, the purpose i s to explore some o f the issues that must be addressed ifthe government wishes to develop good policy proposals, and to demonstrate the need for rigorous analysis o fthe fiscal impacts o f any proposal. The model i s above all a means o f conducting such fiscal impacts analyses. It i s not in itself the starting point for elaborating civil service reforms, which should be driven by a comprehensive strategy that addresses legal and ethical frameworks, institutional needs, human resource management, and general management practices and work culture. Civil service reform measures must also be consistent with sectoral needs and broad-based reforms o f the structure and functions o f the public administration. While models such as this one can and should serve as fiscal checks on specific reform proposals, they cannot be the principal or sole drivers o f such proposals. Reflecting data availability, the present version o f the model i s a pilot that focuses on the headquarters offices o f 10mini~tries.''~For this subset o f the civil service, it projects the impact o f position-by-position changes to pay and employment levels over a five year time frame, as well as associated costs for severance pay, unemployment benefits, and employer contributions. The model allows users to easily adjust key parameters and to create their own sample scenarios in a matter o f minutes. The baseline is a set o f consolidated data representing employment in 10 o f 12ministries(Table 1). Ifadditional data become available, the model could, with relative ease, be expanded to include the entire civil service. A less detailed model could also be developed for the non-civil service staff who account for the bulk o fthe government workforce o f over 300,000. The pilot model is attached as Annex 3 inelectronic versions o f this chapter. It can also be obtained from the World Bank's Europe and Central Asia Division, Poverty Reduction and Economic ManagementDepartment (ECSPE). 'I5'The Ministriesof Defenseand Interiorare excluded. Since datafor the Ministry o fForeignAffairs were not yet available, the modelassumesthat ministry's employment structure is the same as the average for the other nine ministries. 155 L avg monthly staff Avg. annual wage bill, Annual wage e salary, som monthly som bill, USD V salary e USD I Minister T 13.850 10 $286 1,662,038 $34,340 First Dep Minister T 10,917 10 $226 1,310,068 $27,068 Dep Minister T 9,105 14 $188 1,475,088 $30,477 Headof Office C 6,378 8 $132 596,959 $12,334 Other Chief position(ministry-specific) C 5,400 5 $112 298,060 $6,159 Headof chief dept S 6,498 7 $134 522,471 $10,795 Press Secretary s 1 $0 $0 Headof division s 6,018 32 $124 2,282,056 $47,150 Deputy Headof Division s 5,623 31 $116 2,057,947 $42,520 Head(Chief)of Detached Dept s 5,040 44 $104 2,655,177 $54,859 Headof Department s 4,033 11 $83 532,394 $11,000 Advisorto Minister 3,914 6 $81 267.685 $5,531 Headof Dept of the Division ss 3,977 34 $82 1,617,902 $33.428 Head(ChiefJof Unit (sub-unit)of Chief Division 8 3,662 18 $76 790,911 $16,341 Ass! Minister 3,201 9 $66 349,587 $7,223 Asst Dep Minister ss $0 $0 Sector Chief s 3,740 35 $77 1,566.482 $32,365 Other Chief position(ministry-specific) s 3,811 33 $79 1,509,211 $31.182 Chief specialist J 3,139 340 $65 12,794,561 $264,350 Lead specialist J 2,438 208 $50 6,072,358 $125,462 Specialist1. Category J 1,959 96 $40 2,254,170 $46,574 Specialist J $0 $0 Non-CS Technical(Whitecollar) TR 1,423 51 $29 864,247 $17.856 Non-CS Service staff (bluecollar) 777 791 117 $16 1,112,629 $22,988 Annual wage bill, BASELINE Saff annual wg Bill Us) Total, HP, budget-financed: 1,116 42,591,998 $880,000 Civil servants 949 40,616,122 $839,166 Non-civilservants 168 1,976,876 40,845 Compression, dep.minister:specialistcat 1 4.6 Assumptions and Scenarios For the scenarios presented here, these assumptions apply: The pay and employment structure o f the entire civil service is the same as that for the headquarters offices o fthe 10 ministries. The total number o f civil servants i s 24,000, and all are "live" staff, not vacant posts.l16 Newly unemployed workers receive a severance benefit o f 3 months' pay at an average salary o f 3,700 som, and collect a monthly unemployment benefit o f 625 som for 12months. No inflation, and a stable exchange rate o f USD 1=48.4 som. All changes take effect on the first day of each year. `I6' Governmentdata list 23,957 staffof managementbodiesof ministries and agencies, whichthis exercise takes to be a proxy for the civil service, inthe absenceof moredefinitivedata. 156 Some of these assumptions clearly depart from reality, but are usedhere for the sake of simplicity. (Similarly, although the model allows for position-by-position increases, for simplicity the scenarios award the same percentage increase to all positions in a given grade. Real reforms would, of course, consider the internal structure of the wage scale, positionby position.) The model can, in fact, easily be adjusted to test more realistic assumptions or policy proposals. This should certainly be done to assess the costs of transitional support to unemployed workers-including severance, unemployment, and other programs such as retraining or entrepreneurshipsupport-since the Kyrgyz Republic will needto develop and implement aproactive policy inthis area prior to commencing reforms. Scenario 1: Widespreadincreases,decompression,no employmentreductions The strategy in this scenario gives raises to all civil service grades over a five-year period, but also decompresses the salary scale by giving proportionally larger increasesto eachhigher grade. Employment levels are unchanged. Ineachofthree years, earningsincreases(relative to theprevious year) are: 11percent to the Top grade; 9 percent to Chief; 7 percent to Senior; 5 percent to Junior. By year five, gross monthly earnings increaseto $482 for ministers(from $286 inthe baseline), the highest post inthe Top grade $203 for the highest Chiefpost ($132 baseline) $188 for the highest Senior post ($134 ba~eline"~)and $83 for the highest Junior post ($65 baseline). The lowest civil service salary (Specialist 1) rises to $52 ($40 baseline). The compressionratio rises to 6.1 (4.6 baseline). 'I7Consolidateddata for all ministries yield a wage for the top ofthe Senior grade greaterthanfor the Chiefgrade. This undesirable feature is currently possible inpart due to the numerousdiscretionary allowances and bonuses, whichallow for significantdifferencesacross ministries and individuals. 157 Table 2: Scenario 1Outcomes, Baselineto Year 5 Baseline Year 1 Year 3 Year 5 Cumulative costs of reform over baseline Annual wage bill, US$ $21,233,24 $22,601,08 $25,631,46 $29,106,93 -- 2 7 7 Wage bill, cumulativecost over _ _ _7_ _- -_ $22,547,31 baseline Employercontributionsat 25 $5,308,3 11 $5,650,272 $6,407,867 $7,276,734 --8 percent Employercontributions, cumulative cost over baseline Unemployment costs Severance costs Total $26,541,55 $28,251,35 $32,039,33 $36,383,67 $28,184,14 3 8 4 1 7 Total civil servants 24,000 24,000 24,000 24,000 -_ Table 2 summarizes the fiscal impacts o f this strategy at the beginning, midpoint and end years, and in total. By year 5, the annual wage bill i s 37.1 percent ($7.9 million) higher than the baseline, with the accompanying rise in employer contributions costing an additional $2.0 million. Over the five years, cumulative total costs (wage bill plus employer contributions) o f implementing this strategy rather than maintaining the baseline situation are $28.2 million. Key Points While this scenario decompresses the wage scale by awarding generous increases to those at the top (a cumulative increase o f 69 percent by year 5), staff in the lower ranking Junior and Senior grades, who face the greatest economic pressures, receive only 5-7 percent increases per year (cumulative increases o f 28-40 percent by year 5). This i s a concern since these grades contain the bulk o f the work force; official regulations currently requirethat 70 to 80 percent o f staff be inthe Junior grade. The scenario also gives no increases to non-civil service white-collar staff (e.g., typists) or blue-collar staff who work alongside civil servants, which may cause workplace resentments and wage demands from these groups, as well as others. As with every scenario, given the fact that the reforms incur net costs, the question arises as to how the government will finance the cost o freforms and whether it can continue to finance the higher costs inthe medium and longterms. 118Presidentialdecree no. 364, December28,2000. 158 Scenario 2: Widespreadincreases, decompression, employment reductions in year 5 This variation o f Scenario 1 attempts to mitigate the cost o f the above increases through moderate employment reductions inthe larger grades, which take place inyear 5. Earnings increases are the same as in Scenario 1. Ineach of three years, the increases are: 11percent to the Top grade; 9 percent to Chief; 7 percent to Senior; 5 percent to Junior. Employment in Senior and Junior grades i s reduced by 10 percent at the start o f year 5, i.e. after 4 years o f wage increases. Table 3 summarizes the fiscal impact o f this strategy at the beginning, mid-point, and end years, and in total. By year 5, the annual wage bill i s 25.6 percent ($5.4 million) higher than the baseline wage bill, with employer contributions $1.4 million higher than the baseline. Over the course o f the five years, cumulative total costs-including unemployment benefits, severance payments, and employer contributions-of implementingthis strategy rather than maintaining the baseline situation amount to $26.0 million. Table 3: Scenario2 Outcomes, Baselineto Year 5 Baseline Year 1 Year 3 Year 5 Cumulative costs of reform over baseline Annual wage bill,USD $21,233,24 $22,601,08 $25,631,46 $26,660,00 -- _- 5 Wage bill, cumulative cost over $20,100,386 baseline Employer contributionsat 25 $5,308,3 11 $5,650,272 $6,407,867 $6,665,001 -_ percent Employercontributions, _ _ $5,025,097 cumulativecost over baseline Unemploymentcosts -- _- $353,904 $353,904 Severance costs __ _ _ -- -- $523,778 $523,778 Total $26,541,55 $28,251,35 $32,039,33 $34,202,68 $26,003,164 3 8 4 8 Total civil servants 24,000 24,000 24,000 21,716 -2,284 Key Points Inaddition to the key points highlightedfor Scenario 1above, this scenario raises issues regarding the feasibility of implementing employment reductions, and their sequencing relative to pay increases. Reductions take place in year 5, on the assumption that meaningful restructuring and management reforms inthe interveningyears are necessary inorder to target reductions effectively, on objective grounds (Le., to minimize damage to service delivery, and decision-making based on political or personal affiliation). The trade-off, however, i s that-because the reductions take place after significant wage increases-the cost reductions are relatively modest. Furthermore, since the reductions 159 result in social costs to displaced workers (and their families), the question arises of whether a robust program of assistance is in place to help them make the transition to otherjobs. Scenario 3: Employment reductionsfollowed by widespread increases, decompression This variation of Scenario 1 explores the possibility for raising salaries only after employment reductions have runtheir course, inorder to limit expenditureson wages and related costs. Comparing Scenarios l a and lb illustrates the fiscal impact o f sequencing, giventhe same wage and employment measures. Earnings increases are the same as inScenario 1. Ineachof five years, the increases are: 11percent to the Top grade; 9 percent to Chief; 7 percentto Senior; 5 percent to Junior. Employment in Senior and Junior grades i s reduced by 10 percent prior to any wage increases being awarded. Table 4 shows the fiscal impacts of this strategy. Inyear 5, the annual wage bill is 25.6 percent ($5.4 million) higher than the baseline wage bill, with employer contributions $1.4 million higher -the same as inScenario 2. From year 0 through year 5, the reforms result incosts of $13.1 million, comparedto $26.0 million inscenario 2. Table 4: Scenario 3 Outcomes, Baseline and Year 0 to Year 5 Baseline ByYear 0 Year 1 Year 3 Year 5 Cumulative costs of reform over baseline Annual wage bill, $21,233,24 $19,389,20 $20,650,05 $23,446,88 $26,660,00 -- US% 2 5 Wage bill, -_ _4_ _0_ _4_ _- $9,744,368 cumulative cost of reforms Employer $5,308,311 $4,847,301 $5,162,512 $5,861,721 $6,665,001 -- contributionsat 25 percent Employer _- -- -- -- _ _ $2,436,092 contrib., cumulativecost o f reform Unemployment $353,904 _- $353,904 Severance __ _ _ $523,778 _--_ -- __-- $523,778 Total $26,541,55 $25,114,18 $25,812,56 $29,308,60 $33,325,00 $13,058,14 3 6 2 5 6 I Totalcivil 24,000 21,716 21,716 21,716 21,716 -2,284 servants 160 Key Points This scenario arrives at the same end point-in terms o f wage bill and employer contribution costs-as Scenario 2. However, the sequencing results in a very different fiscal impact for the period covered. Because employment i s reduced prior to increasing wages, wage bill and employer contribution costs are lower in years 1 to 4 (as the increases are paidto fewer workers), and total reform costs are significantly lower than in Scenario 2. Related challenges - such as financing and sustainability o f reforms, and how to target employment reductions effectively and objectively - remain undiminished, o f course. Issues for Consideration The hypothetical scenarios presented here are designed to highlight the fundamental challenges facing policy-makers. Since few, if any, easy solutions exist, the aim here i s to promote an awareness o f the multiple concerns that must be dealt with in order to develop a workable solution for the particular needs o f the Kyrgyz Republic, and also to stress the importance o f assigning adequate resources and time to the development o f pay and employment policy. The scenarios are inno way intended to recommend a particular course o f action. The following are among the issues that mustbe considered. In deciding any salary increases or employment cuts, social welfare and equity concerns connected to the large numbers o f lower-paid staff must receive careful attention. Particularly in an economy such as the Kyrgyz Republic's, where employment generation i s difficult and even employed workers are under financial pressure, developing proactive policies to help displaced workers make a transition to other livelihoods i s essential. These are complicated issues, and the government will need to do substantial work to design practical, effective and affordable, options; this undertaking should draw upon technical expertise and the experience o f other countries (for example, Colombia) that have faced similar challenges. Since the civil service i s only one segment o f government employment-and a small one at that-it i s entirely possible that some o f the funds needed to finance wage increases might come from restructuring that affects the other, much larger, groups o f government employees. Similarly, changes to the civil service wage scale will reverberate beyond the civil service itself. Specifically, changes will upset existing pay relativities with other groups o f government employees, who may inturndemand wage increases. Under the current discretionary system o f bonuses and allowances, it is impossible to ensure that increases inthe wage bill will in fact translate into the target increases in total earnings by position. Since entities could well redistribute bonus funds (for example) in a manner that differs from the strategy underlying the policy proposal, central authorities have little ability to ensure that the policy i s implemented as designed. 161 The sequencing o f any wage increases, employment cuts, and other institutional and managerial reforms must be thought through. While rapid earnings increases might offer some hope for improving retention and recruitment o f desired workers, without improvements to the institutional environment in which such staff operate, administrative weaknesses will remain entrenched. Likewise, awarding large wage increases to posts slated for restructuring in the near term will incur costs without contributing to sustained performance improvements. A considerable challenge in any selective employment reduction-even for sophisticated organizations with comparatively small workforces - i s how to target reductions predominantly based on objective grounds (including employee performance) while minimizing subjective or arbitrary action (for example, selection based on personal or political affiliation). One medium-termprospect i s to link cuts to formal performance appraisals, where such a system i s in place and provides reliable feedback. e In the absence of rigorous review, policy proposals may produce unintended and undesirable consequences (for example, in the case o f inequitable wage increases, pressure to promote staff into the preferred positions). As much as possible, the evaluation o f policy proposals should consider the impact o f changes to incentives facing individuals and organizations. 162