Report No. 43280-TJ Tajikistan Second Programmatic Public Expenditure Review (In Four Volumes) Volume I: Main Report June 12, 2008 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank CONTENTS Introduction .................................................................................................................................... xi Preface ............................................................................................................................................ ix Executive Summary..................................................................................................................... ... xi11 1. A Introduction......................................................................................................................... 1 Macroeconomic and Fiscal Developments.............................................................................. 1 . B Growth of Output and Spending......................................................................................... 2 D FiscalPolicy........................................................................................................................ C Inflation and Food Prices.................................................................................................... 3 ... 3 E.External Debt ...................................................................................................................... 4 F.Monetary Policy.................................................................................................................. 5 G.Prospectsand RisksFacingthe Tajik Economy ................................................................. 6 ...................... 6 Vulnerability to a BOP Crisis............................................................................................ Aggregate Demandand Inflation ............................................................... , 6 H Policy Reforms Requiredto Addressthe Macroeconomic RisksandChallenges.............77 . External DebtDistress....................................................................................................... Macroeconomic Management........................................................................................... 7 External Debt Strategy....................................................................................................... 8 Investments andReforms ................................................................................................................ 2. The Implications for Public Finances and Fiscal Sustainability of Electricity Sector 9 A.Introduction.,....................................................................................................................... 9 B Energy Investments.............................................................................................................. 9 C External Public Borrowing ............................................................................................... 10 D Impact on Government RevenueandExpenditures ......................................................... ... 13 Government Revenue...................................................................................................... 13 Government Expenditures............................................................................................... 14 Net Impact on the Budget ................................................................................................ 15 E Quasi-Fiscal Deficits and Contingent Liabilities.............................................................. . 16 Quasi-Fiscal Deficits ...................................................................................................... -16 Contingent Liabilities for UnusedPower........................................................................ 17 3. Public Financial ManagementReforms and Implementation of Policy-Based Budgeting in Tajikistan ....................................................................................................................................... 21 A Current Status ofPFM System......................................................................................... 21 B Public Financial Management Strategy inTajikistan....................................................... .. 22 C. Policy-Based Budgeting.................................................................................................... 24 Status of PFM and Budgeting Systembefore PBB......................................................... 24 What has been achievedso far?....................................................................................... 25 Key Challenges and Agenda Moving Forward ............................................................... 26 V 4. 29 A Strategic TargetsAnd RecentReforms inSocial Sectors................................................ Challenges inTHE EducationandHealth Systems............................................................... . 29 Strategic Targets inthe Context of MDGs and PRSP..................................................... 29 Recent Government Reform Effort in Social Sectors ..................................................... 30 B.Key Budget Trends........................................................................................................... 31 C ........................................................... 34 D HealthPETS ..................................................................................................................... ..Intrasectoral Efficiency Analysis And Challenges 37 Introduction ..................................................................................................................... 37 Allocation of Public Resources ....................................................................................... 40 Health Care Personnel..................................................................................................... 40 E Education PETS ................................................................................................................ . Regional Distribution..................................................................................................... -42 43 5. Conclusion andPolicy Recommendations............................................................................ 49 List of Tables Table 1.1: Macroeconomic Aggregates 2004-07 ............................................................................ 1 Table 1.3: Monetary Data, 2004-07 ................................................................................................ 6 Table 1.2: Fiscal Aggregates as Percentof GDP. 2004-07 ............................................................. 4 10 Table 2.2: Projections of External Debt Indicators: 2007-30........................................................ Table 2.1:New InvestmentsinEnergy Projects (US$ million) .................................................... 12 Table 2.3: Energy-RelatedRevenueand Expenditures: US$millions, 2007 Prices.................... -12 Table 2.4: Energy-RelatedRevenueand Expenditures: Percent of GDP...................................... 19 Table 2.5: ProjectedValue of Power PurchaseAgreements and Contingent Liabilities of Barki Tajik, US$ millions 2007 prices, 2010-30.................................................................... 19 Table 3.1: Comparison of Original Budgeted and Actual Expenditures, 2003-07 ........................ 21 Table 4.1: MDGIndicators and RelatedFinancial Estimations for Health and Education, 2003-15 .......................................................................................................................... 30 Table 4.2: Public Spending on Education and Health (percent of total) ....................................... 32 Table 4.3: Public Spending on Education and Health (excluding PIP financing) ......................... 35 Table 4.4: Comparison of Original Budgeted and Actual Expenditure inHealth and Education, Table 4.5: Availability of Communal Services inHealth Facilities.............................................. 2005-07 ......................................................................................................................... 36 41 Table 4.6: Public Expenditures on Healthby Oblast, 2005 ........................................................... 42 Table 4.7: Jamoat Allocations to Schools ..................................................................................... 45 Table 4.8: Regional Variation inSchool Size, Teaching Hours, Pupil-Teacher Ratios, and Class Size ................................................................................................................................ 47 Table 4.9: Proportion of Principals that Reported Problems......................................................... 48 vi List of Figures Figure 1.1: Contributions to GrowthinNominalExpenditure of Real GDP Growth. Growth in the GDP Deflator. and Changeinthe Trade Deficit...................................................... 2 Figure 1.2: Price Indices for Bread. All Food Items. Services. and the CPI. January 2005 to February2008 (December2004 = 100) ........................................................................ 3 Figure 2.2: ProjectedQFD as Percentof GDP with andwithout Tariff Increaseto LRAIC ........11 Figure 2.1:NPV of PPGDebtto GDP: Projections 2008-30 ....................................................... Figure 2.3: ProjectedQFD as Percent of GDP with andwithout Tariff Increaseto LRAIC .......11 16 Figure 4.1: Public Expenditure inEducation and Health by Classification Items. 2002-06 ........33 Figure 4.2: Organizational Structure of Government Health System Figure 4.3: Public Health Expenditures by Category in% of Goods and Services Expenses......39 ........................................... Figure 4.4: Share of Facilities Receiving Funds or In-KindInputs. in% of Total Facilities........39 39 vii PREFACE The Programmatic Public Expenditure Review (PPER) was launched by the World Bank in May 2006, at a workshop with officials o f the Government o f Tajikistan (GOT), under the leadership o f the Minister o f Finance. At that workshop it was also agreed to undertake a Public Expenditure Management and Financial Assessment (PEFA), which is a comprehensive diagnostic assessment o f the state o f the public financial management (PFM) system based on a comparison with internationally agreed benchmarks. The PPER i s supported by some o f the development partners o f Tajikistan, notably the UK Department for International Development (DFID).The work on PFM is carried out inclose coordination with UNICEF and the European Commission (EC). The PPER is closely aligned with ongoing reforms to PFM, such as introduction ofthe Medium - Term Expenditure Framework (MTEF) and the technical assistance required to support these reforms. The PPER will support the PFM reforms through analytical and diagnostic work. The PPER has been designed to cover five themes that represent the key concerns of, and that confront, fiscal policy and PFM reforms inTajikistan: Theme 1:Public Expenditure, Fiscal Space, and Growth Theme 2: Policy-Based Budgeting(PBB) Theme 3: Challenges of Public Expenditure inthe Social Sectors Theme 4: Fiduciary Risks Theme 5: IntergovernmentalFiscal Relations The PPER is being undertakenover three fiscal years (2006/07-2008/09) and publishedinthree annual reports, o f which this represents the second. The work in PPER 1 covered two of the issues under theme 1-the implications o f public expenditures for economic growth and long- term fiscal space for priority expenditures. This work supports the need to analyze how scarce budget resources can best be allocated to meet the GOT's developmental objectives for growth and poverty reduction. PPER 1 also included an outline of the strategy for implementing the MTEF and a summary o f the PEFA results, which support the GOT's decision in2006 to begin implementing the MTEF in2007. This report, PPER 2, is a sequel to PPER, which was publishedinJuly 2007. PPER 2 provides a detailed analysis o f key public expenditure issues in Tajikistan and reports on the nonlending policy dialogue and technical assistance programs managedand coordinated by the World Bank. PPER 2 has a special focus on social sectors, especially the health and education sectors. Public Expenditure Tracking Surveys (PETS) carried out for the first time in Tajikistan in 2007 contributed to the findings in this report. The report also updates the macroeconomic and fiscal ix situation to take account of important developments in 2007 and analyzes the implications of energy sector reforms and investments for fiscal sustainability. This report was task managedby SudharshanCanagarajah. Chapter 1was written by Sudharshan Canagarajah. Chapter 2 was written by Martin Brownbridge under the guidance of Raghuveer Sharma and Sudharshan Canagarajah. Chapter 3 was written by Matin Kholmatov with input fiom Svetlana Proskurovska, Mario Sangines, Shuhrat Mirzoev, Parvina Rakhimova, Armen Yeghiazaryan, and Vahram Avanesyan. Chapter 4 was written by a team consisting of Utkir Umarov, Jariya Hoffman, Shuhrat Mirzoev, and Matin Kholmatov; the section on health PETS was written by Sarosh Sattar, and education PETS was written by Dina Abu-Ghaida and Nathan Smith. We are thankful to Kazi Matin, Luca Barbone, Annette Dixon, Chiara Bronchi, and Mehrnaz Teymourian for their overall guidance and support for the preparation of this report. We also would like to acknowledge the active collaboration and overall guidance we received from the Tajik government counterparts -namely, Mr.MatlubkhonDavlatov (State Advisor on Economic Policy); Mr. Negmatjon Buriev (Senior Advisor, Executive office of the Presidential Administration); Mr. Safarali Najmiddinov (Minister of Finance); Mr. Abdujabbor Rakhmonov (Minister of Education); Dr.Nusratulloh Faizulloev (Minister of Health). We acknowledge the active collaboration of Ministry of Finance officials, especially Shavkat Sohibov (Deputy Minister of Finance) and Nazrullo Abibullayev (Director, Budget Department). Local government officials inthe finance, education, and health departments of the oblasts and rayons as well as staffs working in the education and health sectors generously took their time to meet with, discuss, and provide information to the survey team during their visits to the rayons and oblasts. We also acknowledge the efficient work of the Center of Sociological Research "Zerkalo," which assisted us in fielding the health and education PETS surveys. Last, but not least, we acknowledge the generous financial support received from Department for International Development (DFID), UK, without which the interesting work on health and education PETS would not have been possible. X INTRODUCTION Tajikistan i s a poor country that faces difficult challenges arising from geography, history, and profound institutional weaknesses. Governed as the Tadzik Soviet Socialist Republic from 1929 to1991, the country i s only 15 years old and, in this early stage o f its independence, i s still experiencing residual effects o fthe flawed Soviet institutions it inherited. Tajikistan experienced strong macroeconomic growth between2000 and 2007, averaging over 8 percent per annum, but over the last two years Tajikistan's economic management was complicated by mismanagement o f macroeconomic stability and extremely cold weather inthe 2007-08 winter, which worsened the chronic energy shortages from which Tajikistan suffers even during milder winters. The worldwide food crisis has also taken its toll on the country, which saw a 27.5 percent food price inflation rate in 2007, including a 49.6 percent rise in the price o f bread. As bread comprises an estimated one-third of the food consumption basket in Tajikistan, the jump in prices has had a significant effect on living standards, particularly for the poorest segments o f the population. Though crises o f this magnitude and scope could threaten the well-being and growth potential o f a country with a considerably stronger economic structure, they have not deterred Tajikistan from belief in its dream of achieving the status o f energy exporter. This report examines the challenges Tajikistan faces in achieving that ambition as well as those o f the Millennium Development Goals (MDGs) that relate specifically to health and education. As the analyses inthis report demonstrate, consensus about the significance o f these goals does not automatically translate into unified commitment to actions required to achieve them. It's one thing to find consensus on the definition of the problem, and another to agree on a course of action that will produce an effective, sustainable solution. Tajikistan i s no exception to this challenge. Mindfulof these complex realities, the authors of this report have conducted in-depthanalyses not only o f first-level problems (maintaining macroeconomic stability, achieving prudent fiscal investment, undertaking conducive budget reforms, renovating schools that lack heating, and ameliorating the problems o f medical facilities that suffer a high rate o f absenteeism among the medical staff,) but also the underlying causes o f those problems (lack o f fiscal and monetary discipline, investment choices not guided feasible returns, capacity constraints in the budget system, inefficient administration o f school funding, medical professionals taking secondjobs to supplement inadequate salaries). The objective is not only to understand the challenges better, but also to gain a more comprehensive understandingof the challenges inherent in proposed solutions. xi This report i s intended to contribute to improving the quality of life in Tajikistan through a comprehensive reform program. It spells out the macroeconomic, energy, and budget reforms necessary to achieve the growth the country seeks and, at the same time (and frequently via the same measures) the social welfare targets of the MDGs. xii EXECUTIVESUMMARY 1. The objectives o f public finance include supporting sound macroeconomic management and promoting long-term sustainable growth through supply-side reforms that strengthen physical and human capital and reduce poverty. The PPER 2 analyzes several key issues pertaining to public financial management and related policy objectives: macroeconomic management; the long-term implications o f energy investments for the sustainability of public finances; public financial management reform; and allocation o f scarce public resources to best achieve policy priorities in key areas such as education and health. Each issue has direct relevance to crucial policy questions facing the Government o f Tajikistan. This report, like the earlier report PPER 1, aims to contribute to the policy dialogue within Tajikistan and among the GOT and donors. 2. Chapter 1 o f the PPER analyzes macroeconomic policy and performance. Sound fiscal policy significantly aided the marked improvement in macroeconomic stability that Tajikistan achieved in the first half o f the 21st century. Regrettably, macroeconomic management weakened in2006 and 2007 and, together with supply-sideshocks such as rising energy and food prices, led to a deterioration in macroeconomic performance. This deterioration was manifested in rising inflation (to an annual rate of almost 20 percent at the end of 2007), widening trade deficits, and a worsening of external debt indicators. The authorities also revealed in October 2007 that the National Bank o f Tajikistan (NBT) guaranteed US$328 million of external loans to Kredit Invest (KI), an insolvent Tajik private sector financial institution. These guarantees included the depositing o f US$241 million o f the NBT's foreign exchange reserves in creditor banks as collateral against the loans to KI, which left the country with only US$107 million of unencumbered gross official reserves at the end o f 2007. In addition, the NBT provided domestic credits equivalent to about 8 percent o f GDP to KI, thereby expanding the supply o f reserve money almost threefold. The combination o f very rapid growth o f Somoni monetary liabilities and the depletion o f foreign exchange reserves leaves the country vulnerable to a potential balance of payments crisis. The deterioration o f macroeconomic policy i s in part attributable to problems in specific sectors, such as cotton, and the weaknesses o f governance. Over the longer term, macroeconomic stability could also be threatened by developments inthe energy sector, especially ifthe GOT fails to implement the reforms needed to eliminate the large quasi fiscal deficit (QFD) in the sector, or funds investment in new energy projects through public borrowing to the extent that debt sustainability i sjeopardized. 3. Unless prompt action i s taken by the GOT to restore sound macroeconomic management, the country risks an extended period of macroeconomic instability that will deter private investment and the inflow of remittances and encourage capital flight, which in turn will Xlll ... jeopardize the prospects for sustaining strong real growth rates. The economy may also face a balance o f payments crisis that would almost certainly have severe adverse consequences for growth in the short to medium term. The key macroeconomic policy actions required to avert a balance-of-payments (BOP) crisis and restore macroeconomic stability include implementing a tightened monetary policy supported by fiscal consolidation, rebuilding the central bank's foreign exchange reserves, and enforcing strict quantitative ceilings on new external public borrowing to ensure debt sustainability. 4. The generation o f hydroelectric power i s an area in which Tajikistan enjoys a comparative advantage. This industry's development could provide a major source o f export earnings and be a driver o f economic growth over the long term. Because o f the nature o f the industry, a major role for the public sector is unavoidable. The sector will be called upon to directly provide key components o f public infrastructure and to contribute, alongside the private sector, to investment in hydropower generation plants. Its role would extend to regulating and probably guaranteeing long-term electricity supply contracts. 5. Government involvement in the development o f the hydropower industry will have profound consequences for public finances over the long term, an issue analyzed in chapter 2 o f the PPER. The chapter evaluates the fiscal impact of reforms to the domestic electricity market as well as investments in the CASA 1000 OTL and major new generation projects. The key messages o f this chapter are twofold. First, the GOT must be cautious about committing large amounts o f public funds to investment in new power projects, because o f the consequences for debt sustainability. The majority of finance for these projects should be provided by the private sector. Second, raising the domestic electricity tariffto the L M I C o f supply i s a prerequisite for both the financial viability o f the electricity industry and the sustainability of public finances. 6. The major reform required in the area o f domestic market electricity is raising the average tariff to the long-run average incremental cost o f supply, resulting in substantial net fiscal benefits. Indeed, failure to eliminate the quasi-fiscal deficit (QFD) would reduce fiscal space and present a threat to fiscal sustainability over the long term inTajikistan. 7. Investment in the CASA 1000 OTL has relatively minor consequences for the fiscal position. This i s because the GOT'S financial share in the project cost i s only US$127 million (which will be spread over several years) and can probably be financed on highly concessional terms by external lenders. However, the investment in the CASA 1000 OTL alone, without new investment in generation capacity, will not yield major fiscal benefits in terms o f increased revenues. 8. Investment in new hydroelectric power projects (HPPs) and thermal power projects (TPPs), for which the GOT is expected to contribute about US$900 million (spread over the period 2008-2021) inaddition to already constructed assets, has a more profound fiscal impact: it increases the risk o f debt distress and creates contingent liabilities for the budget, but it could xiv also mobilize significant budget revenue and make a positive net contribution to the budget if well managed. The new power generation projects will entail liabilities for Barki Tajik (BT) in terms o f guarantees it undertakes to purchase power from the generators on a take or pay basis. These liabilities o f BT should be recognized as contingent liabilities o f the government budget. 9. The public financial management (PFM) system in Tajikistan suffers from serious weaknesses that impede bothallocative and technical efficiency o f expenditures. Comprehensive PFM reform i s a prerequisite to enable scarce public resources to be used more efficiently to achieve public policy objectives, an issue addressed in chapter 3 o f the PPER. This chapter highlights the areas where progress has been made (such as developing MTEF strategy, basic budget guidelines, and streamliningannual budget and MTEF processes) as well as areas where substantial reform effort i s still needed (addressing budget fragmentation, streamlining interactions between budget organization at different levels, merging capital and recurrent budgets). The main focus o f the PFM reforms currently being implemented i s the introduction, on a pilot basis in the education sector, o f the MTEF. The status o f these reforms and the challenges ahead is analyzed indetail inthe chapter. This chapter argues that the key challenges relate to the need to strengthen institutional capacity to undertake comprehensive PFM reforms at all levels, including revisions inthe budget classification system and establishment o f external and internal audit functions. Inaddition, there is a need to better coordinate ongoing and planned activities within the framework o f the overall PFM strategy (sequencing and prioritization) and, finally, the need to promote and ensure the government's ownership o f the PFM reform agenda. 10. Chapter 4 o f the PPER focus on the challenges Tajikistan faces in the health and education sectors. Tajikistan's current labyrinthine system o f funding public education creates barriers to optimal use of money. Some funding is disbursed by the central government and flows down to the local school level, while other revenue sources are collected at the local level and flow up. Recordkeeping (with regardto both income and expenditures) is adequate at some governmental levels and nonexistent at others, making it impossible to track an uninterrupted trail o f financing or determinethe point(s) at which leakages are occurring. As a consequence, it i s impossible to guarantee that funds from any source will reach their intended destination or be available for their intendeduse. 11. Policy reform in health and education sectors can be more difficult to implement consistently and effectively in an environment in which there is no clear line o f governmental authority. The implementation of policy reform requires an exercise o f political will that can be successful only to the extent that the government is in a position to enforce the reform strategy. When different levels o f government are responsible for different line items in the public education budget, the funding structure, as well as the process, lacks essential cohesion. By devising a plan to address these structural deficiencies, the government o f Tajikistan could promote an environment in which reform i s more likely to succeed and, by extension, funding i s putto more effective andequitable use. xv 12. Hence this chapter argues that Tajikistan can make substantial progress toward achieving the education and health MDGs by improving allocative and operational efficiency o f expenditure. It has the opportunity to realize efficiency gains by aligning allocation o f education andhealth sector resources with subsector resource requirements. 13. The PPER 2 argues that, given the country's narrow economic base, the government cannot afford ambitious and expensive infrastructure or social development programs. A sequencing strategy for government development projects i s essential with a sustainable debt strategy given the "high debt distress" Tajikistan currently faces. In addition, under that circumstance, it becomes essential to spend wisely and efficiently and to optimize technical capacity and efficiency. These can combine to allow Tajikistan to fulfill its potential for increased economic growth, reduced poverty, improved mortality and enrollment rates, as well as other benchmarks o f sound policy and practice inall critical sectors. xvi 1. MACROECONOMICAND FISCALDEVELOPMENTS A. INTRODUCTION 1.1 Reform of macroeconomic management in Tajikistan was a key factor in stimulating the economic recovery from 1995 to 2005. Beginning in 2006, however, macroeconomic performance deteriorated. Although real GDP growth remained strong, inflation accelerated to almost 20 percent at the end of 2007. Furthermore, trade and current account deficits and public debt rose sharply, while unencumberedforeign exchange reserves fell to the equivalent of only two weeks of imports. Table 1.1presents data on key macroeconomic and BOPvariables. Table 1.1: Macroeconomic Aggregates 2004-07 2004 2005 2006 2007 NominalGDP (SMmillions) 6,158 7,201 9,272 12,780 RealGDP growth 10.6 6.7 7.0 7.8 Nominalexpendituregrowth (percent) 31 33 36 50 Inflation(percent) 5.6 7.1 12.5 19.8 Public investment(percentof GDP) 8.1 7.8 6.8 14.1 Privateinvestment(percentofGDP) 5.1 6.0 6.0 7.0 Balanceoftrade on goods and services -12 -27 -34 -46 (percent ofGDP) Currentaccount balance(percentof GDP) 4 0 -2.7 -3.0 -9.5 Unencumberedforeign exchangereserves 189 91 111 107 (US$ millions) Source: IMF. 1.2 The major cause of the deteriorating macroeconomic performance is a weakening of macroeconomic management. Although rising international food and fuel prices gave a supply side boost to domestic inflation, the primary drivers of poor performance were as follows: In the last few years, Tajikistan experienced a boom in private consumption expenditures. This was driven in part by strong growth of remittances and an expansionary monetary policy and fiscal stance. Together, these factors exacerbated growth in aggregate demand to levels far beyond growth in aggregate supply capacities, a recipe for increasedinflationand widening trade deficits. 0 The central bank-the NBT-lost control of the money supply. Broad money grew by 60 percent in2006 and 78 percent in2007. a The NBT undertook quasi-fiscal activities such as direct finance and external loan guarantees to a privately owned financial institution, ostensibly for cotton financing. The external loan guarantees mainly took the form o f pledging the NBT's own foreign exchange reserves as collateral deposits. NBT loan guarantees and new external borrowing by the GOT for infrastructure projects led to a sharp rise in outstanding public and publicly guaranteed external debt and an associated worsening o f the country's debt indicators. B. GROWTH OUTPUTAND SPENDING OF 1.3 In 2007, real GDP growth was 7.8 percent, slightly higher than in the preceding two years. However, consumer price inflation also rose for three successive years, to 19.8 percent in 2007 (Table 1.1). 1.4 Buoyant domestic demand has been a key feature o f the economy in recent years. This has accelerated the pace o f economic recovery and provided a stimulus to bring capital, labor, and land, which had been left underutilized by the severe contraction o f the 199Os, back into the factors o f production. However, as growth in demand outstripped supply capacity, external and internal imbalances emerged. The nominal growth rate o f total expenditure inthe economy-the sum of public and private consumption and investment expenditures-averaged around 30 percent inthe mid-2000s, but in2007 this growthjumped to 50 percent (see Figure 1.1). 1.5 The tradeoff between Figure 1.1: Contributionsto Growthin NominalExpenditure real GDP growth on the one of RealGDP Growth,Growthin the GDP Deflator, and hand, and inflation and the Changein the Trade Deficit trade deficit on the other, has 60 - worsened as nominal spending growth has accelerated. Figure 50 - 1.1 shows the annual growth in total expenditure from 2004 to 2007 and each year's - 40 . equivalent supply-side 30 - n counterparts. In 2004, almost a third of the growth in nominal 20 - spending was met by higher real GDP, but with accelerated 10 - growth inspending, real GDP's contribution to the increase in 0 2004 2005 2006 2007 total spending has fallen to Year about a sixth. Most o f the 2007 Source: Derivedfrom IMF data. growth in nominal expenditure Note: Ineach year, the growth of real GDP, the growth of nominal GDP manifested in higher inflation attributable to the change inthe GDP deflator, andthe trade deficit are expressed as percentagesof the previousyear's total expenditure. and a wider trade deficit in 2 goods and services. Since capacity constraints limit the rate at which real GDP can grow in the short term, when nominal spending growth accelerates beyond the maximum potential rate o f supply side growth, the higher spending must find its outlet either as a larger trade deficit or as higher domestic inflation. The wideningo fthe trade deficit was drivenmainly by a huge increase inimports, which morethandoubledindollar values between2005 and2007. c.INFLATION AND FOOD PRICES 1.6 Buoyant demand and supply side shocks accelerated inflation in 2006 and 2007. Food price inflation rose fastest, to 15.8 percent in 2006 and 27.5 percent in 2007. As global wheat prices skyrocketed, the price o f bread, which constitutes about one-third o f the total food basket inTajikistan, rose by 5.9 percent in2006 and a staggering 49.6 percent in2007. 1.7 Figure 1.2 shows the Figure 1.2: Price Indices for Bread,All FoodItems,Services, and price indices for bread, all the CPI, January2005 to February2008 (December 2004 = 100) food items, services, and all 200 - consumer items from January 2005 to February 2008. The 180- Bread +Food price of services also rose, by +Services 8.3 percent in 2006 and 17 160- percent in 2007. Only among nonfood goods items was 140- inflation relatively subdued. 120- Prices rose 5.3 percent and 7.7 percent in2006 and 2007, 100 respectively, which probably i reflects the impact o f the relative stability o f the exchange rate on the prices of imported manufactured Source: Derived from GOT inflation data. goods. D.FISCALPOLICY 1.8 Fiscal performance in the last two years was characterized by strong growth in both domestic revenue and state budget expenditures along with a large increase in externally funded capital expenditures in2007. The latter ledto a sharp increase inthe 2007 overall fiscal deficit. 1.9 Domestic revenue almost doubled in nominal terms between 2005 and 2007, increasing from 19.3 percent o f GDP in 2005 to 20.5 percent in 2007. The growth in indirect taxes, especially VAT, made the largest contribution to the rise indomestic revenue, which reflects the rapid growth in aggregate expenditure, especially private consumption. The nominal growth in indirect taxes was no faster than that of private consumption during 2005-07. Therefore it is 3 doubtful whether improved revenueperformance will prove sustainable once the current boom in expendituressubsides. 1.10 State budget expenditures also rose quickly in nominal terms, by 27 percent in 2006 and 30 percent in 2007, with salary growth (42 percent in 2006 and 27 percent in 2007) making a major contribution to the expansion of the state budget. State budget expenditures rose slightly less in nominal terms than domestic revenue and grants, which increased the fiscal surplus, excluding the externally financed public investment program (PIP), from 0.5 percent of GDP in 2005 to 1.8 percent of GDP in2007 (Table 1.2). 1.11 Concerns about the sustainability of external debt constrained PIP expenditures to less than 4 percent of GDP in 2000-05, but they leapt to 8.6 percent of GDP in 2007. The increase was attributable to large infrastructure project launches financed by loans from China. The jump inexternally funded project expenditures in2007 sparked an overall fiscal deficit increase from 2.9 percent of GDP in 2005 to 6 percent of GDP in 2007.' This was the largest fiscal deficit incurredsince the mid-1990s. Table 1.2: FiscalAggregates as Percentof GDP, 2004-07 2004 2005 2006 2007 Domestic revenue 17.3 19.3 18.9 20.5 Grants 0.7 0.7 4.7 1.1 Total expenditure 20.3 23.0 21.9 27.6 Current expenditure 12.1 15.1 15.0 13.4 Capital expenditure 8.1 7.8 6.8 14.1 PIP 3.1 3.4 3.1 8.6 Overall deficit -2.4 -2.9 1.7 -6.0 Deficit excluding PIP 0.7 0.5 0.8 1.8 Net externalfinancing 4.0 2.6 1.6 6.9 Domestic financing -1.7 0.3 -3.3 -1 .o Source: IMF. E.EXTERNALDEBT 1.12 In2007, PIP expenditure financing hada profound impact on the country's external debt dynamics. Debt relief provided by the Russian Federation, Pakistan, and the IMF (under the Multilateral Debt Relief Initiative) had, by the start of 2006, reduced the country's debt ' The overall fiscal surplus of 1.7 percent of GDP recordedin 2006 is somewhat misleading because it includes as revenue and grants the US$99 million (3.5 percent of GDP) of debt relief provided under the Multilateral Debt Relief Initiative. Ifthis were excluded from revenue and grants, the overall fiscal balance would be a deficit of 1.8 percent of GDP. 4 indicators to levels at which external debt is deemed sustainable for a low-income country. But the external loans contracted from China, which have a nominal value of more than US$600 million and will be disbursedduring 2007-09, will sharply raise Tajikistan's debt indicators over the medium term. An early 2007 Joint Fund-World Bank Debt Sustainability Analysis (DSA) concluded that "as a result of the rapid debt accumulation ... debt distress risk has increased significantly and could be now classified as high" (IMF and World Bank, 2007, p. 1). 1.13 Subsequent to the DSA, the NBT disclosed that it had guaranteed US$328 million of private sector external commercial loans, which had been extended mainly by foreign banks to Kredit Invest, a financial institution involved in financing the cotton trade. Consequently, although precise data on the debt indicators are not yet available for end-2007, it is almost certain that the net present value of external public and publicly guaranteed (PPG) debt will exceedthe sustainable debt thresholds of 40 percent of GDP and 150 percent of exports in2008. F.MONETARY POLICY 1-14 The NBTlost control over the money supply in2006 and 2007. Reservemoney expanded by 48 percent in 2006 and 40 percent in 2007, while broad money, which includes foreign exchange deposits held by Tajik residents in commercial banks, rose by 60 percent in 2006 and 78 percent in the following year. Money supply growth was accompanied by 44 and 59 percent growth in credit to the private sector in 2006 and 2007, respectively (see Table 1.3). Such rapid growth of monetary aggregates almost inevitably creates destabilizing internal and external imbalances. 1.15 The rapid growth inreserve money despite negative domestic borrowingrequirementsin 2006-07 appears to have been propelled chiefly by domestic credit of SM885 million (about 7 percent of GDP) that the NBT extended to Kredit Invest (the same financial institution to which it provided external loan guarantees). Furthermore, the NBT's efforts to mop up the liquidity it had itself created, using sales of securities (NBT bills), were not very aggressive. The interest rate onNBT bills barely rose above 7 percent in2006 and 2007, eventhough inflation was rising steadily, which meantthat the real yield on NBTbills became progressively negative. 1.16 TheNBTdepositedUS$245 millionof its own foreign exchange reserves as collateral for the external commercial loans of Kredit Invest (which is unable to service its loans). These reserves are, therefore, encumbered. Consequently the NBT's foreign reserves, which were not very high even before the loan guarantees were extended, were reduced to only about US$lOO million, or the equivalent ofabout two weeks of imports. 5 Table 1.3: Monetary Data, 2004-07 2004 2005 2006 2007 Broadmoney (includingFX deposits) growth (percent) 14.3 29.9 60.2 78.3 Broadmoney (excludingFX deposits) growth(percent) 146.0 55.2 38.3 Reservemoney growth(percent) 10.0 28.8 48.5 40.2 Private sector credit growth (percent) 57.9 29.7 43.8 57.8 NBT bill interest rate (percent) 6.2 7.0 7.7 7.3 Source: IMF. G. PROSPECTSANDRISKS FACINGTHE TAJIKECONOMY 1.17 The economy faces serious medium-termrisks as a result o f recent policy mistakes. The most serious risks are (i)an acceleration o f inflation, (ii)a BOP crisis, and (iii) external debt distress. Real GDP growth is likely to fall in the short term because o f the supply-side shocks that hit the economy in the first quarter o f 2008: widespread electricity shortages disrupted several sectors o f the economy and agriculture was adversely affected by the severe winter weather. Medium-term economic growth could be curtailed by continued highinflation, which is likely to undermine investor confidence and could spark inflows o fremittances and capital flight. AggregateDemandandInflation 1.18 Inflationary pressures are likely to remain strong over the short to medium term, for several reasons: Given the lags in the transmission mechanism o f monetary policy, even if the NBT reigns in 2008 money supply growth, the huge 2007 increase in the money supply will provide an impetus to spendingand inflation in2008. 0 Total government expenditures are budgeted to increase by 2.6 percentage points o f GDP in 2008. This includes a 53 percent increase inthe wage bill. Consequently, the overall fiscal deficit will widen and the fiscal balance excluding the PIP will move from a surplus in 2007 to a deficit in 2008 (an expansion o f about 1.5 percent o f GDP). The budgetedincrease in domestic borrowing in 2008 will impede the NBT's efforts to reduce the growth o f reserve money. Rising international prices for grains and fuel, together with planned increases in electricity tariffs, will continue to exert pressure on inflation. Vulnerabilityto a BOPCrisis 1.19 The large increase inthe domestic currency supply since 2005 has created an overhang of domestic currency assets. Private agents could seek to change these assets into foreign currency assets if they believe that domestic currency value will fall relative to foreign currencies. This would generate a leap indemand for foreign exchange and a fall inthe nominal exchange rate. 6 1.20 The NBT's pledge of its foreign exchange reserves to secure external borrowing for Kredit Invest leaves almost no unencumbered foreign reserves to defend the exchange rate. A sharp depreciationofthe exchange rate is likely to have serious adverse economic consequences due to inflationary pressure arising from higher prices o f imported goods and services and increased costs of imported inputs. By extension, commercial banks with very large foreign exchange-denominated liabilities will face potentially serious risks to their soundness, and investors' confidence inthe economy's stability will be undermined. External Debt Distress 1.21 The GOT'S ability to restore external debt sustainability will depend on its future borrowing strategy. Debt stock indicators can be brought back to sustainable levels over the medium term if the GOT restricts the volume o f new borrowing to around 4 percent o f GDP per year and contracts loans only on concessional terms. Contracting much higher levels o f external credits or o f loans on commercial terms will leave debt stock indicators above sustainable thresholds. Debt servicing indicators will also rise, leaving the country vulnerable to a debt crisis inthe longterm. H.POLICYREFORMSREQUIREDTOADDRESS THE MACROECONOMICAND RISKS CHALLENGES 1-22 Macroeconomic policy priorities should be to restore macroeconomic stability, avert the risk o f a balance of payments crisis, and ensure long-term external public debt sustainability. Sustainable economic growth should be promoted through supply-side reforms that attract more private investment and improve the efficiency o f resource use inthe economy. Macroeconomic Management 1.23 Short- to medium-term macroeconomic management should focus on dampening aggregate demand growth reducing inflation and the current account deficit, and minimizing the riskofa BOP crisis. 1.24 Reducing aggregate demand growth requires a tightening o f fiscal and monetary policies, with much lower rates of money supply growth than were recorded in 2006 and 2007. To control reserve money and simultaneously increase foreign exchange reserves requires a reduction in government borrowing from the NBT. This will create resources NBT can use to purchase foreign assets. The 2008 budget projects government borrowing from the NBT at 0.5 percent of GDP. Tightened fiscal policy would ensure that the government can save with the NBT. 1.25 The NBT's foreign exchange reserves should be rebuilt in a gradual manner, with the NBT allowing an orderly depreciation o f the exchange rate. While the risk of a BOP crisis cannot be eliminated, it can be reduced if: (i) macroeconomic policies dampenaggregate demand and thus reduce the external sector deficits; (ii)money growth rates are sharply cut, which 7 reduces the amount of domestic liquidity that i s available for purchasing foreign currency; (iii) the nominal exchange rate depreciates in an orderly manner, which makes purchase o f foreign currency more expensive; and (iv) the foreign exchange reserves are rebuilt. It would be very helpful for macroeconomic management if the country's international donors were to provide budget support to the GOT to supplement the NBT's foreign exchange reserves. External Debt Strategy 1.26 The GOT should implement a strategy for new external borrowing to ensure the long- term sustainability o f external PPG debt. There are three key elements o f such a strategy: Formulate and adhere to quantitative annual ceilings on new external borrowing, calibrated to bring the external debt indicators back down to the thresholds at which external debt i s regarded as sustainable for an economy like that o f Tajikistan. These ceilings should cover all PPG debt, including that contracted by parastatals. 0 Contract new borrowing only on concessional terms. Place legal constraints on the authority o f the NBT and other parastatals to contract or guarantee external debt. 8 2. THE IMPLICATIONS FOR PUBLICFINANCESAND FISCAL SUSTAINABILITY OFELECTRICITY SECTOR INVESTMENTSAND REFORMS A. INTRODUCTION 2.1 The CASA (Central Asia-South Asia) 1000project consists of investments inmajor new hydroelectric and thermal power plants and reforms inthe domestic electricity sector. It involves generating electricity in Tajikistan and the Kyrgyz Republic and transmitting it via a 1,000 MW overheadtransmission line (OTL) to Afghanistan and Pakistan. The line could transmit power to Afghanistan and Pakistan using summer surplus power production from Tajikistan. However, eventually large new investments in power generation will be needed in Tajikistan to meet increasing domestic demand, provide sufficient power for year round exports to Afghanistan and Pakistan, andbridge the large power shortfalls inwinter. 2.2 The GOT will contribute to the investment costs of the CASA 1000 OTL andnew power projects, in collaboration with other stated, private investors, external public sector entities, and international financial institutions. The key reforms to the domestic electricity sector involve raising the domestic tariff to the level required to cover the long-run average incremental cost (LRAIC) of supply. B. ENERGY INVESTMENTS 2.3 Table 2.1 shows the capital cost and GOT share in investments in one transmission line and five power generationprojects. The total capital cost of the CASA 1000 OTL is estimated at US$455 million. The figures presentedassume the GOT will fundthe capital costs of that part of the OTL that is located inTajikistan, which is estimatedat 27 percent, or US$123 million. 2.4 The GOT'S contribution to these projects from 2008 to 2021 will total just over US$l billion, or on average US$SO billion a year, in 2007 prices, plus existing assets. This is equivalent to about 2 percent of GDP. Ofthat total, more thanhalfis attributable to the coal-fired TPP. The GOT will assume ownership of the Sangtuda I1 project, and thereby acquire its revenue, after 12.5 years of operation. Table2.1: New InvestmentsinEnergyProjects(US$ million) GOTcontribution Project Capital Cost GOTShare ExistingAssets Cash CASA 1000OTL * 455 27% 123 SangtudaI1 220 40 Coal FiredTPP 2,250 25% 563 DushanbeReconversion 309 25% 77 Rogun I 1,035 32% 250 79 Rogun I1 2,220 32% 550 161 Total 6,489 800 1,042 Sources: SNC-Lavalin, World Bank. * Total costof OTL includingparts outsideTajikistan. C. EXTERNALPUBLICBORROWING 2.5 The following analysis assumes that all of the GOT'Scontribution of US$1.04 billion to the investment costs of these projects will be fundedby external public borrowing. There is very little scope inthe state budget to accommodateinvestment costs of this magnitude and almost no scope for domestic borrowing given the very shallow domestic financial sector. Therefore, this analysis assumes that the GOT will fund its contribution to the CASA 1000 OTL by borrowing on IDA terms and that, for all other projects, the external loans required by the GOT will be contractedfrom nontraditional lenders on semi-concessionalterms. 2.6 Table 2.2 shows debt projections that adopt the 2007 DSA baseline, adjusted for developments in2007, and add the projected external debt stock and debt servicing requirements of: (i) borrowing on IDA terms for the CASA 1000 OTL and (ii) borrowing for all the the the power projects listed inTable 2.1, 2.7 Figures 2.1 and 2.2 show one the key debt indicators used to evaluate debt sustainability, the net present value (NPV) of external debt to GDP. The measure of external debt on which it focuses is PPG debt. It is likely that some of the non-GOT investment inthe power projects will be funded by external debt, but these projections assume that this will not be guaranteed by the GOT. 2.8 The CASA 1000 OTL borrowing has little impact on these debt indicators. At most, it adds 1.4 percent of GDP to the NPV of PPG external debt to GDP ratio and 5.6 percentage points of exports to the NPV of PPG external debt to export ratio, both in2010. Interms of debt servicing, this borrowing adds less than US$1 million per year until 2019, when principal repayments start to fall due, and then rises to averagejust over US$3 millionper year during the 2020s. Hence, the borrowing requirement for the CASA 1000 OTL alone does not undermine external debt sustainability. 10 Figure 2.1: NPV ofPPGDebt to GDP: Figure2.2: Projected QFDas Percent of GDP with Projections 2008-30 and without Tariff Increase to LRAIC 50 45 +DSABaseline -a- With C A S 1000 OTL 40 +With all projects 35 -30 25 20 15 o8 ,,e 11 ,2 13 14 15 17 2O 21# 25 4 5 6 7 8 8 0 2o 2o 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2~ 2022022022022022022~3 Source: World Bank staff estimates. 2.9 The borrowingrequiredto fund the GOT'Scontribution to all of the power projects has a much more significant impact on debt indicators because the amounts involved are much larger and the borrowing for the power generation projects is on less concessional terms. The borrowingrequirementsfor all the power projects add 11.4 percentagepoints of GDP to the NPV of PPG external debt to GDP ratio (in 2014) and 53 percentagepoints of exports to the NPV of PPG external debt to export ratio (also in2014). The addition of these loans delays the reduction of the NPV of PPG external debt to GDP ratio below the sustainable threshold of 40 percent by five years (from 2010 in the adjusted DSA baseline to 2015) and that of the NPV of PPG external debt to exports to below the sustainable threshold of 150percent by 15 years (from 2012 inthe adjustedDSAbaselineto 2027). The debt servicing requirementsof all ofthe projects add an average of US$34 million in2007 prices to external debt servicing duringthe period 2008-30 butthis does not raise the debt service to exports ratio abovethe threshold for debt sustainability of 15 percent. 11 2 : a n a 0 a a D D 3 33 Y 3 2 1 3 P3 3 L 3 D 3 I3 2 3 23 2a4 .. : ? 2, 3 F ! D. IMPACT ONGOVERNMENT REVENUE AND EXPENDITURES 2.10 The energy-related investments and electricity sector reforms will have a long-term impact on government revenue and expenditures. GOT revenue will be mobilized through the income earned by government investments in the energy projects, possible taxes on electricity exports, andthe impact of higher domestic electricity tariffs on VAT. GOT expenditureswill be affected by the debt servicing costs of borrowing to fund energy projects along with the impact of increased electricity tariffs on government utility bills and compensation payments to low- income electricity consumers. 2.11 Tables 2.3 present the revenue and expenditure projections assuming that all of the new investmentsinthe power projects listed inTable 2.1 are undertaken. GovernmentRevenue Income earnedfrom power projects 2.12 The GOT should earn income on its own investments in each of the power projects. For each project, with the exception of Sangtuda 11, the GOT will earn income from debt (interest and repayment of principal) and equity inthe project. The methodology and assumptions usedto makethe projections are explained inthe backgroundpaper. 2.13 In 2007 prices, the revenue earned from GOT capital invested in the power projects climbs rapidly from US$16 million in 2011 to almost US$l50 million in 2015 and then to US$200 million in 2020. It continues to rise before flattening out at around US$245 million in the second half of the 2020s. This revenue rises to a peak of 3 percent of GDP in2016 and then recedes to 1.3 percent by 2030. 2.14 These projected earnings should be regarded as the maximum the GOT could mobilize. They assume all the HPPs and TPPs are operating at maximum capacity for at least 8 months of the year, which would generate an average of GWh 40,000 per year from 2015 to 2030. As annual domestic demand in this period averages approximately GWh 20,000, the annual exportable surplus will average almost GWh 20,000. This compares with the transmission capacity of the CASA 1000 OTL of only GWh 11,388 per year and that of the AFG 220 OTL of GWh2,628 per year. 2.15 Note that the power generation system in the Kyrgyz Republic will also generate an exportable surplus that would need to be transmitted through the CASA 1000 OTL. Unless additional capacity is added to the CASA 1000 OTL to transmit electricity exports, the new power generation projects will operate at much less than full capacity and the returns to capital will be substantially reduced. 13 Export royalty 2.16 Another potential revenue source could be a royalty of 0.25 cents/KWh (in 2007 prices) on all exports of electricity generated in Tajikistan. This would yield US$26 million in 2007 prices (a maximum of 0.4 percent of GDP). If the capacity of the CASA 1000 OTL were to be increased to enable all the surplus generated in Tajikistan to be exported, the revenue from the export royalty would be much higher, by an average of about US$36 million per year during 201O-30.HoweverYany royalty on exports could underminetheir commercial viability. Corporate income tax 2.17 The financial projections of the costs of generation and transmission compared with the likely export purchase price of power suggest that the projects may be viable, in terms of yielding a sufficiently high rate of return to investors, only if they are exempt from corporate income tax. Given that the HPPs must charge a tariff of 3-3.5 cents/KWh to generate pretax returns to equity capital inthe region of 15 percent, that the transmission tariff i s assumed to be 2 centsKWh, that the purchase price in Pakistan is unlikely to exceed 6 cents/KWh, and the potential export levy of 0.25 centsKWh (all in 2007 prices), the scope for levying corporate income tax without reducing after tax rates of return below the level needed to attract private capital would appear to be limited. However, power sector investors should be granted income tax concessions only if they can be justified following a comprehensive social cost benefit analysis of eachproject. 2.18 BT is liable to pay income tax, and its revenue should increase substantially when the average domestic tariff i s raised to the LRAIC. However, these projections do not incorporate any additional income tax payments by BT, because it will need this revenue to fund the necessary repair and maintenance of the transmission and distribution infrastructure. Value-addedtax (VAT) 2.19 The increase inthe average domestic tariff to the LRAIC (calculated as 2.3 centsKWh in 2003 prices) will boost gross VAT paid on electricity sales by an average of US$56 million per year from 2010 onward. However, the net VAT gain will be much smaller, because increased electricity tariffs will reduce consumers' purchasing power for other VAT-able products. This translatesto anet gain inVAT averages of US$11 million in2007 prices from 2008 to 2030. GovernmentExpenditures Debt servicing 2.20 In2007 prices, the cost of servicing energy project debt rises from US$3 million in2010 to almost US$50 million in2020 before flattening out at aroundUS$55 million inthe first halfof the 2020s. It begins to fall back in the second half of the 2020s as (i) service payments, set debt 14 innominal terms, fall inreal value over time due to inflation, and (ii) nominal value of debt the i s reducedby the repayment of principal, and interest payments fall. Government electricitypayments 2.21 Domestic tariff increases will drive the GOT'Sown electricity expenses up substantially. The World Bank proposes2that tariffs for government consumption be raisedto 4.58 centsKWh, in constant 2006 prices, by 2010. Under this scenario, in 2010 the higher tariff will increase government electricity bills by US$17 million in 2007 prices over the baseline 2007 tariff; this will riseto US$40 millionby 2030. Payments under the energy compensation mechanism 2.22 Under the current energy compensation mechanism (ECM), the GOT pays for a fixed monthly volume of electricity consumption of eligible households whose aggregate household income falls below the average monthly salary for the applicable rayon. If(i) the residential tariff for consumers who consume less than KWh 250 per month rises from 0.8 centsKWh in2007 to 3 centsKWh (at 2007 prices) in2010 and then remains constant in subsequent years, and (ii) the full cost of this price increase will be absorbed by the ECM, up to the maximum annual consumption allowed per eligible household, then in 2007 prices, this will increase the ECM's budgetary costs by US$14 million in2010 risingto US$21 million by 2030. Net Impacton the Budget 2.23 Higher tariffs on government electricity bills and the ECM outweigh net gains from higher VAT and result in a negative net impact on the budget until 2012. Beginning in 2014, a large increaseinincome from projects reversesthe net budgetary impact, which remainspositive until2030. Projections show the net impact rising in2001 prices from US$66 millionin2014 to US$176 million in 2025 and then flattening. Net budgetary gains reach a maximum of 2.5 percent of GDP in2016 but then gradually decline. 2.24 Over the period 2008-30, net budget impact averages US$110 million in2007 prices and 1.2 percent of GDP. This amounts to about 5 percent of projected government revenue over this period. Hence, electricity investments and reforms make a modest net contribution to budget revenue but do not represent a major source of fiscal space that could fund a large expansion of public expenditures. * These areset out inthe "World Bank Commentsand Suggestionson the Proposalofthe Governmentof Tajikistan to Adjust ElectricityTariffsto ReachFinancialViability Levelsby 2010," May 2006. 15 E. QUASI-FISCAL DEFICITSAND CONTINGENTLIABILITIES Quasi-Fiscal Deficits 2.25 The electricity industry's quasi-fiscal deficits (QFD) were estimated at nearly 10 percent o f GDP in 2006. In essence, this QFD i s the deficit between the revenue BT needs to earn to operate and properly maintain the electricity supply network and the revenue that it actually earns from the sale o f power to domestic customers. The main consequence of incurring a QFD i s that BT fails to devote adequate resources to the necessary maintenance and repair o f the transmission and distribution network. 2.26 The causes o fthe QFD inthe electricity sector are threefold: (i) average tariffs that are set at levels below the LRAIC o f supply (a proxy for the marginal cost o f supply); (ii) excessive technical and commercial losses; and (iii) losses attributable to noncash collection of electricity bills. 2.27 To eliminate the electricity sector QFD, it i s necessary to raise the average tariff to the LRAIC o f supply (and maintain it at that level in real terms); reduce technical and commercial losses to the international norm o f 10 percent; and reduce noncash collections to the international norm o f 2 percent. Failure to eliminate the QFD will eventually create either a burden on the government budgetor a breakdown inelectricity supply capacity. 2.28 BT has started to implement reforms to eliminate the QFD. Domestic tariffs were raised in 2006 and 2007. Investments in metering and billing systems reduced technical and commercial losses from 22 percent o f supply in 2003 to 17 percent in 2007, and noncash collections were reduced from 46 percent in 2003 to 18 percent in 2007. Nevertheless, there i s still some way to go to eliminate the QFD, and some o f the future reforms needed, especially further raising the average domestic tariff, are likely to prove politically contentious. 2.29 Figure 2.3 shows Figure2.3: Projected QFD as Percentof GDP with projections for the QFD based on and without Tariff Increaseto LRAIC two alternative scenarios. The first i s the implementation on schedule o f the tariff increases to the LRAIC, together with the necessary improvements to distribution systems, billing, and collection that will bring technical and commercial losses and noncash collections down to international norms. Under this scenario the QFD i s eliminated Source: World Bank staff estimates. by 2010. 16 2.30 Under the second scenario, there are no further real increases in average domestic tariffs after 2007 (tariff increases merely keeppace with inflation). As a consequence, the QFD remains a persistent problem, although it declines to 2.6 percent o f GDP by 2030. The initial fall in the QFD as a percent o f GDP i s mainly attributable to the reduction in technical and commercial losses and noncash collections. Further falls occur because domestic electricity consumption grows more slowly than real GDP, so the value o f domestic electricity supply falls as a share o f GDP. 2.31 In 2007 prices, the average annual reduction in the QFD over 2010-30 as a result of raising electricity tariffs i s US$206 million, compared with the average direct net cost to the budgetofUS$35 million. Hence, raisingthe electricity tariffs improves the fiscal position, taking fullaccount o f"off-budget" effects, by anaverage ofUS$170milliona year. ContingentLiabilitiesfor UnusedPower 2.32 The projected investment in new generation plants amounts to about US$6 billion, of which US$4.2 billion will be provided by investors other than the GOT. Because o f the particular monopolistic structure o f electricity transmission and distribution systems, investors in generation capacity face substantial market risk once their investments are "sunk" unless they have legally binding long-term agreements with power purchasers to guarantee that the power generated will be sold at prices that are economically viable for the generators. As such, a precondition o f new investment in power generation capacity will be the signing o f long-term PPAs between the generator and future purchasers o f its output. Such PPAs are often termed "take or pay" because the purchaser must pay for the power even if it cannot sell it to final consumers. 2.33 Some o f the power generated by the new HPPs and TPPs will be sold to BT for domestic consumption and will be covered by a PPA signed by BT and the generators. The arrangements for the power that i s intended for export are potentially more complex. There are three possible arrangements: (i) the generator sells the power to BT, signing a PPA with BT for this power, and BT then resells the power to a third party; (ii) generator sells the power to an intermediary the such as the company owning the CASA 1000 OTL and signs a PPA with this company (the intermediary would then seek to sign a PPA with the importer); or (iii) generator sells power the directly to the importer and signs a PPA with the importer. 2.34 The first o f these arrangements i s the essence o f the PPA signed between BT and Sangtuda Iand a similar agreement likely to be signed between BT and Sangtuda 11. This means that BT has a liability to purchase power at predetermined prices even if it cannot resell this power to domestic consumers or to importers inAfghanistan and Pakistan. 2.35 As most of the power produced by the Rogun HPP and the coal-fired TPP will be exported, it is possible that their investors will sign PPAs with both BT and a foreign electricity purchaser (inPakistan) to diversify the risk. 17 2.36 IfBT will commit itself to purchase (i)all the power intended for the domestic market (500 MW of the power generated by the TPP and all the power generated by the reconverted TPP in Dushanbe), and (ii) half the power produced by Rogun and the TPPs that is intendedfor export, the liabilities arising from the PPAs would then become a financial cost to BT in the event that the power purchased for domestic consumptioncannot be sold at a price that covers all costs. This i s a plausible outcome under several scenarios. First, lower than projected real GDP growth will reduce domestic demand. Second, a sharp depreciationo f the real exchange rate will raise the real value o f the domestic tariff, denominated in Somonis, needed to ensure full cost recovery, because the purchase price o f power stipulated in the PPAs will be denominated in U.S. dollars. Third, it may prove politically difficult to raise tariffs to the levels required to ensure full cost recovery. These liabilities would also become a financial cost to BT inthe event that power exports fall short o f projected levels, whether because o f disruption to the transmission system or because importers will not purchase the expected volumes o f power. These liabilities to take or pay for power on the part o f BT are in effect contingent liabilities on the GOT budget. BT is a government-owned entity, and any impairment of its financial condition that undermines its capacity to supply the domestic market with electricity will ultimately have a fiscal impact. 2.37 Table 2.5 presents projections of the liabilities o f BT arising from take-or-pay PPAs. The total value o fprojected revenue from new power generation projects, and hence the total value o f PPAsthat generatorswill seek to sign, rises to around US$750 million per year in2007 prices by 2022 and then flattens out at this level. Given the assumptions about BT's share o f the PPAs discussed above, BT's liabilities will rise to US$450 million per year by 2020 and then flatten out at this level. As a percentage o f GDP, BT's liability peaks at 7 percent in 2016 then declines to 3 percent by 2030. While it is unlikely that all o f these liabilities will materialize as costs to BT (this would require both a collapse indomestic sales and exports), it is not implausible that a fraction of these liabilities translate into costs for BT, and ultimately for the government budget, if the domestic economy performs much more poorly than expected or if there is serious disruptionto electricity exports after the sunk costs o f new power projects have beenincurred. 18 - 7 ° F W O O . - m m v q 0 0 0 0 7 - q - N O O N m O O N N N T ( C ! 0 ? o N - 0 0 0 m y - 0 0 0 0 0 - - 0 0 0 0 0 0 - - 0 o , 0 0 0 0 -0 -0- 0 0 0 3. PUBLIC FINANCIALMANAGEMENTREFORMSAND IMPLEMENTATIONOF POLICY-BASEDBUDGETINGIN TAJIKISTAN A. CURRENTSTATUSOF PFMSYSTEM 3.1 The 2007 Public Expenditure and Financial Accountability Assessment (PEFA) for Tajikistan concluded that a number of public financial management areas covered by the assessment demonstrated good performance. However, the assessment also highlighted serious weaknesses in the areas of credibility, predictability and control of budget execution (tax collection, control of commitments and payrolls, internal audit), accounting recording and reporting, external audit scrutiny, and donor practice^.^ 3.2 The GOT subsequently took actions to rectify PFM system weaknesses identified by the PEFA. 0 Credibility of the budget as an instrument is still rather weak, as deviations between actual and plannedexpendituresare quite significant. A similarpictureis also evident withrevenue (see Table 3.1). Table3.1: Comparison of OriginalBudgetedand ActualExpenditures,2003-07 2003 2004 2005 2006 2007 Budgetedprimary expenditure(mn.Somoni) 571.4 859 1,234 1,501 1,954.3 Actual primary expenditure(mn.Somoni) 668.7 984 1,276 1,619 2,396.4 Difference betweenactual & budgetedprimary expenditure(mn. Somoni) 97.3 125 42 118 442.1 Difference as % of budgetedprimary expenditure(%) 17 14.6 3.4 7.8 22.6 Source: MOF/Treasury. Note:Primaryexpendituresexclude debt servicingpaymentsand foreign and domestic funding of the PIP; funds shown include the CSIP andthe SocialProtectionFund. 0 Initial efforts have been taken to improve comprehensiveness and transparency by establishing a Budget Classification Working Group; results are expected by November 1,2008. See PEFA report (June 2007) for a complete assessment o f results andrecommendations. The government i s progressing well with the development o f the secondpolicy-based budgeting exercise. It encompasses the education sector as a pilot along with initial work inhealth and social protection. Initial focus i s on the basics of the PBB, such as development o f good sector strategies, macro forecasting, better costing, prioritization, and linking budgetsand policies at the ministry level. To improve Predictability and Control in Budget Execution, the Ministry o f Justice registers the standard bidding documents for goods, works, and services and implementedregulations as referred to inthe new public procurement law in January 2008 (adopted inMarch 2006). The new law will be gradually implemented to ensure "fully functional" procurement functions insix government agencies. 0 The MOF has launched an effort to modernize the public sector accounting system that i s consistent with international standards to ensure better accounting, recording, and reporting. A government working group was formed to identify a strategy and action plan to establish an independent external audit in Tajikistan. The action plan is being circulated and discussed inthe government. To coordinate the increasing involvement o f donors and the GOT in the PRF areas, the government has contracted a local consultant to develop a map of donor activities inthe PFMarea. The GOT also is creating a high-level PFM Council to facilitate the development o f a coherent road map for PFM reform in Tajikistan and identify the medium- and long-term priority areas that could be supported by the development partners. 3.3 Tajikistan has also launched a number o f important initiatives to better align public policies with budgets and improve the efficiency o f public expenditures. The Public Administration Reform Strategy (PARS) approved by the GOT in 2006 calls for important PFM- related reforms through the year 2015, including: (i)greater budget-policy coordination; (ii) greater coherence inresponsibilitiesfor PFM, with a view to integrating investmentplanningand the budget process more closely; (iii)establishment of better procedures for financial decision making in ministries; (iv) strengthened internal and external audit systems and introduction of new audit methods; (v) greater effectiveness of public procurement; and (vi) rationalization of revenue allocation mechanisms among levels o f government. These reform efforts are being supported by extensive donor assistance, lending and nonlending, as well as through technical assistance. 3. PUBLIC FINANCIALMANAGEMENT STRATEGYINTAJIKISTAN 3.4 Given the large number o f PFM reform areas that require attention and the active participation o f many donors in the PFM domain, it i s essential to establish a clear strategic framework that avoids duplicative or contradictory efforts and ensures full government 22 ownership. The MOF, with support from an international consulting firm, is preparing the PFM strategy that will be integral to this frame~ork.~ 3.5 In Tajikistan and many other countries grappling with similar transitions, a number of constraints jeopardize formulation of this strategy: Substantial institutional capacity gaps endanger the full and sustainable implementation of reforms. There is a need to balance fiscal decentralization efforts and top-down elements of the PFM strategy where ongoing support from all stakeholders will have to be secured. The MOF has not articulated a broad vision of PFM reforms. Finally, several ongoing initiatives in specific areas of PFM need to be better coordinated as part of the overall strategy. 3.6 Despite these challenges, the MOF is moving ahead with the definition of the strategy and has assigned a working group made up the managers of most of the related departments in the MOF. As part of the preparation of the Public Financial ManagementProject, the Bank has identified a preliminary set of areas of action that should be part of this strategy, together with their sequencing, although boththe content and sequencingwill undoubtedly be enriched during the ongoing process.The preliminary benchmarksofthe strategy are the following: 2008: e Implement budget classification revisions and adopt an organizational (administrative) classification. e Continue pilots for medium-termplanning and budgeting. e Establish targets for adoption of International Public Sector Accounting Standards (IPSAS) accounting and reporting standards. Establish an independent SupremeAudit Institution. 2009: e Strengthenmacroeconomicand fiscal forecasting. e Develop linkages between macroeconomic and fiscal forecasting and formulation of the budget. e Adopt an integrated Budget Classification and Chart of Accounts. e Establishthe fundamentals of an internal auditing framework. 2010: e Introduce modern andtransparent methodologies for debt management. e Develop and initiate implementation of anew PFM ITplatform. e Strengthen the budget execution process, including a commitment control system linkedto the procurementprocess. 4The existence of a government-adopted PFM Strategy is seen as an important prerequisite for successful PFM reforms, as describedinthe "Strengthened Approach to Supporting PFM Reforms" (www.pefa.org). 23 0 Consolidatethe Treasury Single Account and improve cashmanagement. 0 Adopt a formula-basedtransfer systemto subnational governments. 2011: 0 Complete integration of current and capital budgets. 0 Identify and address fiscal risks inthe overall fiscal framework. 2012: 0 Finalize implementation of I T platform. 0 Introduce a program structure to the budget. 0 Develop tools for dissemination of budget information to the public, including interactive web application. C. POLICY-BASEDBUDGETING Status of PFMandBudgetingSystembeforePBB 3.7 Before Tajikistan embarked on a path of piloting elements of policy-based budgeting leading toward an MTEF, as well as developing a comprehensive PFM strategy, the existing budget system was characterizedby a very high level of fragmentation among more than 100key budgetary organizations (KBOs) and a very limited role played by line ministries. As a consequence, the link between national priorities and budgets was virtually nonexistent. The government based its budget planning on conservative revenue forecasts that often led to a situation in which the budget outcome differed considerably from budget plans; for example, actual revenue exceeded budgeted revenue, which enabled actual expenditures to exceed budgeted expenditures. Furthermore, the actual composition o f expenditure differs from the composition in the budget plan. The transparency of the processes for allocating additional expenditures was weak and unclear, with actual allocations being made somewhat mechanically (based on previous year figures adjusted for inflation and certain increase), and often subject to frequent, last-minute changes. The national parliament and budget commission were involved only margina~ly.~ 3.8 Based on the public expenditure and institutional review (PEIR) in 2005, the GOT committed to improvingbudget processes and institutions. DFIDprovided a specialist in2006 to assist with development of a comprehensive and phased MTEF implementation strategy and plana6It was concluded that, given the rudimentary state of budget processes and institutions that are capable of bridging policies and budgets, Tajikistan should start with PBB as its first See PPER 2007 for comprehensivereview o f budgetsystem inTajikistan. 6See PPER(2007), chapter 4 -How can the MTEFbe introducedin Tajikistan. 24 stage, focusing on developing basic sector strategies, macro forecasting, and instituting the mechanisms to link these strategies with budgets. What has been achieved so far? 3.9 Tajikistan has progressed well in the 20 months since inception o f the exercise that focused on introduction of key elements o f the PPB, with the education sector serving as a pilot. Some key milestones (including organizational and institutional) o f the last 20 months' work follow. March Sept. 2006 - Tajik MTEF Strategy is developedand discussedwith the GOT September 2006 First Government Resolution adoptedon ImplementingMTEF inTajikistan October 2006 Educationselectedas a pilot sector and MOE as the lead line ministry February 2007 Regulationon MTEF Introductionand Implementationis issuedby MOF March2007 Educationand finance working groups are createdby MOE and MOF orders April 2007 First educationbudget instructions are developed and issuedby MOF June 2007 Firstbudget framework and sector expenditureceilingsare issuedby MOF August 2007 Three-year MTEF document is issuedby MoF and submittedto Parliament May 2007 Two-day MTEF roundtableheldinDushanbe, Tajikistan July 2007 Study tour by MOF andMOE officials on MTEF and PCFto Slovakia September 2007 Two-dayhigh-levelMTEF workshop heldinKhujand,Tajikistan November 2007 Study tour by MOF officials on MTEF and PPBto Moldova 3.10 During 2006-07, the reform efforts included actions and technical assistance in four key areas: legal framework, procedural and administrative aspects, capacity building for PBB, and better donor coordination. 3.11 Presidential decrees, intraministerial orders, and upcoming changes to the Law o f Public Finance create a sound legal foundation. A wide array o f procedural and administrative aspects have been designed and introduced to facilitate the rollout o f the initial PBB pilot, including setting up operational working groups (within the MOF and MOE), developing guidelines and templates to facilitate the pilot, budget monitoring and reporting, and finally an annual action plan (with key deadlines for the MTEF prepared and synchronized with the annual budget exerci~e).~Initial capacity-building efforts were concentrated on the basic concepts o f strategic budget formation and prioritization. The Finance and Education Ministries' staff and other involved stakeholders have participated in study tours, high-level and execution-level workshops, and daily on-the job training. 3.12 It is of critical importance for all donors to work in the same direction and continue building up and capitalizing on the achievements to date. As an effort to meet this objective, a joint April 2007 donor mission worked closely with the government to coordinate efforts between existing and new donors to providetechnical assistance. A local consultant was hiredin 7See Table 3.4 inVolume 2 o f PPER2 (2007) PFMreforms and implementationo f PBB inTajikistan. 25 November 2007 under the World Bank's PHRD grant to help the MOF coordinate the expanding and increasingly complex donor involvement in the PFM area. A PFM activities mapping exercise has been conducted and a comprehensive matrix prepared that will serve as a starting point for better coordination and harmonization o f donor assistance.* 3.13 Key lessons learned during the last 20 months of implementation o f the initial PBB exercise include: The ministries' instilling ownership o f the process has proved essential to successful MTEF implementation. This i s particularly evident in the ongoing process o f preparingthe PFM reform agenda and strategy. Related to this, starting with the 2009-11 cycle, the government has decided to expand the first-stage PBB expertise to other sectors, such as health, social protection, and agriculture. While this effort is commendable and shows a strong commitment on part o f the GOT, an initial needs assessment should be conducted first to ensure that these sectors can be meaningfully included inthe process. 3.14 Government officials involved in the PBB process have developed an understanding o f the MTEF philosophy, process, and expected outcomes. Key technical staff have been trained in linkages to PFM reforms, PRSP/NDS, sector strategy (in education) and public investment program, and exposed to various experiences from the region, including those o f Slovakia, Moldova, Armenia, Georgia, Russia, and Latvia. Technical and sector staff understand the mechanics of the MTEF, have studied successful cases, and are capable o f continuing with the MTEF2009-11independently with some advice andguidance from the international consultants. 3.15 However, there i s still lack of capacity and technical skills at all levels of the bureaucracy to undertake further MTEF reforms and move to more advanced stages o f PBB. Thus, a comprehensive capacity-building program needs to be developed and funded to ensure that the technical staff at bothnational and regional levels are adequately trained and prepared to implement the reforms Key Challenges and Agenda Moving Forward 3.16 Going forward, priorities are to: (i)strengthen interactions between the M O F and the M O E as lead line ministry (LLM) responsible for the overall policy issues and corresponding distribution o f public resources; and (ii) strengthen interactions among the MOE, line ministries (with educational establishments under their supervision), and KBOs that interact with the MOF independently. 3.17 At present, both the MOF and MOE are prepared to perform the first type of interaction, which does not demand interaction among MOE, other line ministries, and education sector KBOs. This type o f interaction requires an adequate understanding o f the priorities of the education sector development and funding as well as a sound information base on the indicators and benchmarks o f the sector development. * Forfurther details of what has been achieved to date see in PPER2 Background Technical Papers. 26 3.18 The most important immediate steps are (i) bothministriesto streamline their work to for provide aggregate distribution of budget resources in education; and (ii)for the MOE to start interacting with other KBOs and regional authorities (local budgets) through rollout of an intrasectoral budget instruction that should be developed based on the general budget instruction issued by the MOF at the beginning of the 2008 exercise. 3.19 However, the MOE currently is not prepared to fully take over the annual budgeting processinthe sector-that is, build the annual budget on the base of the PBB that i s fundamental for successful implementation of the MTEF. It should be expected that in 2008, MOE and MOF will perform the annual budgeting exercisejointly to provide knowledge and information transfer to the MOE. Full involvement of the MOE within the sectoral MTEF and the annual budgeting process is the main task for the 2010-12 PBB, and this issue should be in the front line of the overall technical assistance provided by the donors. The key focus of the technical assistance shouldbe to (i)supportthe MOF inknowledge and procedurestransfer to the MOE and (ii) help the MOE and sector KBOs achieve institutional preparedness (including through instruction and interaction with other line ministries and local KBOs) and build capacity in PBB by conveying knowledge ofprioritization, costing, budgeting, revenue and expenditure analysis, and so forth. 3.20 Inthe mediumterm, key steps that needto be taken includethe following: (i) merger of capital and recurrent budgets, and gradual integration of the PIP and the state budget; (ii) transfer of responsibility for capital expenditures planning to the MOFY9a step that would require strengthening capacity of the ministry to effectively coordinate ongoing and planned externally funded investment projects; (iii)ceasing the practice of not distributing additional budget resources between the sectors in the process of budgeting (at both PBB and annual budget levels) and keeping these resources as reserves to be distributed later on, usually after adoption of the budget;" (iv) fundamental change inthe revenue distribution structure to implement basic principles of fiscal discipline, replacing current annual adjustment of revenue according to centrally planned expenditures with a system of subsidies from the central budget to local budgets; (v) introduction of a legally binding, permanent, distributional scheme of revenue between central and local governments; and (vi) improving tax forecasting and tax administration and corresponding capacity building inthe relevant government bodies (including MOF). Currentlyunder Ministry of Economic Developmentand Trade. 10The first attemptto do so by the MOF inMarch2008, inthe MTEFbudgetinstruction sent to the MOE and other ministries participating in the MTEF pilot sectors. This practice needs to be continued and reflected in the annual budgetexpenditure ceilings. 27 4. CHALLENGES INTHE EDUCATIONAND HEALTH SYSTEMS A. STRATEGIC TARGETS RECENT REFORMS IN SOCIAL SECTORS AND Strategic Targets in the Context of MDGs and PRSP 4.1 The efficiency of spending on education and health in Tajikistan is examined from two perspectives: the balance o f resources point o f view and input-output efficiency. Obviously, improving the efficiency o f public spending and service delivery i s important for reviving the social sectors. Public sector interventions in these sectors are in the forefront o f efforts to maintain the current system and prevent further declines in both the quality and coverage o f services currently taking place. There is a clear need to streamline and sharpen the policies in both sectors and link these policies to priority actions that are backed up by resources and at the same time address the needs o f those most marginalized. This i s especially relevant given the rising demand for these services and continuing declines in equity, coverage, and quantity o f services currently being provided. Based on the analysis below, actions need to be taken to ensure efficiency gains through a number of actionable measures and addressing inefficiencies through ensuring better outcomes and better alignment o f inputs with outputs. Additionally, increasing public spending in health and education does not necessarily mean improved outcomes in the case of Tajikistan. Therefore, given rather limited fiscal space and the scope to create one, the main focus needs to be placed on improving efficiency, as better outcomes could be achieved evenwith the resources already available. 4.2 Education and health sectors are vital to achieving the MDGs (see Table 4.1). MDGs related to education and health include achieving universal primary education; reducing infant and maternal mortality; and combating HIV/AIDS, malaria, and other diseases. A 2005 World Bank report", however, said Tajikistan was unlikely to achieve these MDGs. According to UNDP Needs Assessment in Tajikistan, the cost o f meeting the education MDG under the baseline scenario i s estimated at about US$1.76 billion, and the cost o f meeting the health MDGs i s estimated at about US$3.6 billion, or US$46 per capita during 2005-15.12 The total cost o f achieving the MDGs (halve poverty and hunger and achieve sustainable human and social development) i s on the order o f US$13 billion over a course of the next 11 years inthe baseline The World Bank (2005), "Millennium Development Goals: Progress and Prospects in Europe and Central Asia Region", Washington,D.C. l2 UNDP (May 2005), "Investing in SustainableDevelopment:Millennium DevelopmentGoals Needs Assessment inTajikistan," Dushanbe,Tajikistan. ~cenario.'~The potential sources o f financing can come from domestic @ublic and private payments) and international donors, while the financing gap i s still significant. Table 4.1: MDGIndicatorsand RelatedFinancialEstimations for Health and Education,2003-15 CategorjdZndicator FY 2003 FY 2005 FY2015 Education Student enrollment 1,664,000 1,767,000 2,204,000 Impliedstudent:teacher ratio 20:1 21:l 22:1 Per student financing(inUSD) 53 89 110 Financing(percent ofGDP) 4.4 5.6 5.9 Health Urbanpolyclinics 103 103 131 Medicalhouses 1709 1709 1742 Salary, doctors (USD, in2003 prices) 100 176 454 Financing(recurrentcosts, inUSD) 116.5 305.3 ofwhich: staffingcosts (inUSD) ___ _ 44.4 151.8 Financingfor HIV/AIDS(mlnUSD) -- 2.7 101.6 Per capitafinancing (inUSD) 16.2 24.0 59.1 Total financingfor MDGs (percentofGDP) 5.1 8.5 12.2 Source: Governmentof Tajikistan,NationalDevelopmentsStrategy. 4.3 Declining education and health services and PRSP indicators prompted both sectors to initiate reforms. The government recognizes the need to reform the education and health systems to ensure that the population's basic needs are met and that the systems are fiscally sustainable. Since implementation o f the Poverty Reduction Strategy Paper (PRSP) in 2003, public spending on education and health has steadily increased to 4 percent and 1.4 percent o f GDP, respectively, in 2006; it currently accounts for one-quarter of the total pubic expenditure (equivalent to 5.4 percent o f GDP in 2006). However, these levels remain low by international standards. The second PRSP for 2006-08 incorporated reform measures intended to reverse declines in the education and health sectors. Recent Government Reform Effort in Social Sectors 4.4 Tajik education has progressed gradually and to date has encompassed curriculum reform and modern textbook development and delivery. A textbook rental scheme has been introduced to ensure adequate supplies for students. Teachers' work loads ("stavka") are reduced through a l3It assumed Gross Domestic Product (GDP) growth o f 5%, tax revenues as a share of GDP at 19%, and the Government expendituresto MDG investmentsequalingto 31% of the totalbudget,the total financinggap stands at US$4.7 billion, or 36% oftotal needs. 30 combination o f increasing teaching hours per week (from 14-16 to 16-18) and reducing the teaching plan (syllabus) by 300 hours. Since 2005, the government has piloted the per capita financing for general education, which is now expanded to 17 rayons to increase autonomy and improve school system financing with the goal o f improved efficiency and quality o f education services. The GOT also adopted the National Strategy for Education Development (NSED), which aims to ensure universal access to basic education, raise enrollment ratios in secondary education, and improve the quality and relevance o f education at all level^.'^ 4.5 Health reform programs are also under way. The Ministry o f Health initiated attempts to rationalize the health system in 1994-96. That led to lowering the length o f hospital stay o f hospital beds, and consequently the reduction in the number o f medical personnel. The government adopted a formula for per capita financing of PHC and introduced the per capita financing in 7 rayons on a pilot basis in April 2007. A national guaranteed package of basic health services was approved and first introduced in2005.15The government has also adopted a Health Financing Strategy16that aims to improve equity, efficiency, and cost-effectiveness of the health system through health financing reforms. The strategy includes an overall increase in public funding to the health sector, and inparticular primary health care; the introduction o f per capita financing for PHC; and the introduction o f a Basic Benefits Package (BBP). This will help the M O H to incrementally move away from input- to output-based financing, and provide a better match between needs and resource allocation. 4.6 However, health and education sector reforms have been slow and erratic. Despite ongoing reforms, traditional and ineffective methods o f financing and procurement are still practiced in most secondary schools and hospitals, which also rely heavily on local discretion. Neither sector has streamlined or strengthened accountability for results and institutional structures for service delivery. Areas o f weakness include organizational structure and linkages between levels o f government and within sectors (for example, balancing priorities, removing inefficiencies, and improving technical efficiency o f spending). Furthermore, assumed system leakages are slowing reforms in the sectors. These factors combine to pose challenges in the implementation o fjoint reform strategies inhealth and education. B. KEYBUDGETTRENDS 4.7 Nominal increases in wages and public investment drove rises in key budget parameters in the health and education sectors from 2002 to 2006. An increase in government revenue generated by strong economic growth and strengthened tax administration has enabled the l4Implementationofthe NSEDstrategy has been supportedby a multi-donor grant "Education For All Fast Track - Initiative" (EFA-FTI)inthe amount ofUS$18 million during2006-07 to support the implementationof the strategy. Other donors have also supportedthe reforminthe educationsector. 15The Ministryof Healthrevisedthe BBP andre-introducedit in3 pilot rayonsinJune 2007. 31 government to increase education and health spending to, respectively, 19.3 and 6.4 percent o f total budget expenditures in 2006 (from 13.5 and 4.8 percent in 2002) (see table 4.3). This i s equivalent to 4.0 and 1.4 percent o f GDP in 2006 (from 2.6 and 0.9 percent o f GDP in 2002). Such increases are consistent with the government's priorities stated in the PRSP to improve the living standards of the population. The share o f education spending in total public expenditure has continued to be the largest, while the share o f health spending ranked the fifth (after social protection, public administration, law enforcement, and defense, indescending order). Per capita spendingon education and healthreached US$11.8 and US$4.5, respectively, in2006, compared with US$4.9 and US$l.7 in 2001. Public investment has increased significantly in response to the need for rehabilitation and maintenance of education and health infrastructure that was destroyed during the civil war and had beenneglected inearly years after the war ended in 1997. In2006, capital expenditure inthe education and health sectors was several times higherthan in 2001,while the recurrent nonwage expenditurecategory lacks significant public resources. 4.8 Financingchallenges at the local government level hinder the benefits o f ongoing reforms in both sectors. Local governments are responsible for providing primary and secondary education and primary health care as well as public health services. Rayons are also responsible for allocating among agencies and defending their budgets at the MOF and thus have more flexibility and discretion in managing their budgets, which does not necessarily translate into quality service delivery and outputs (see Table 4.2). In addition, rayons seem to heavily overspend their available resources to achieve marginal changes in output efficiency performance. Finally, local governments have been shown in PETS to engage in weak accountability and recordkeeping practices, and various levels o f government have beenfound to suffer from inefficient procurement and disbursement practices. Table 4.2: PublicSpendingon Educationand Health (percent of total) 2002 2003 2004 2005 2006 2007 Education Total 100 100 100 100 100 100 Republican 19 18 19 17 19 19 Local 81 82 81 83 81 81 Health Total 100 100 100 100 100 100 Republican 21 25 29 24 24 23 Local 79 75 71 76 76 77 Source: Ministryo f Finance, Republic of Tajikistan. 4.9 Wage bill burden and other expenditure issues lead to uneven distribution o f public resources in both sectors. The government, in accordance with the IMF, has used additional tax revenueto raise wages and salaries, especially for teachers and health workers, which continued 32 to account for the largest share in total budgetary spending. As a result, wage bills increased by close to 260 percent in the education sector and by 340 percent17 in the health sector during 2002-06. These wage increases were accompanied by implementation o f reforms inthe sectors.18 According to the State Statistical Committee, despite a higher increase inthe average wage inthe health sector compared with the education sector (3.3 times versus 2.9 times o f the 2002 levels), the average wage in the health sector has remained lower than that o f the education sector (121 and 41 Somoni per month in2006). Increased wage expenses also have left the government with insufficient resources to allocate to material inputs.l9 This has the boomerang effect o f lowering education and health services efficiency as teachers and health workers are not provided with necessary inputsto enhance their efficiency (see Figure4.1). Figure4.1: PublicExpenditurein Educationand Healthby Classification Items,2002-06 100 n n 90 80 70 60 L 50 2 40 30 20 10 0 -r T- Rep.I -T- -r LocalI Total Rep Local 1 Total FY 2002 FY 2006 FY 2002 FY 2006 Source: Government of Tajikistan and World Bank Staffestimates. l7 The increasesinthe wage bill inthe educationsector were 47% in2002,25% in 2003, 30% in2004, and 63% in 2005. The increases in wage bill in the health sector were 44% in 2002, 22% in 2003, 32% in 2004, and 96% in 2005. '*In the education sector, since the government approved its reform plan in June 2004, class size increases and changes in working practices have been implemented. Reform in the health sector includes implementation of the health financing reform strategy adoptedin2004. 19For example, expenditure on goods and services in the health sector, especially on medicine and food, fell to 41 percentoftotal healthbudget in2006, comparedwith 53 percent in2004. 33 4.10 Allocation o f public resource across regions i s highly inequitable and remained unchanged during 2002-06, which reflects the continued use o f norm-based budgeting. Public spending per capita varies significantly across the region in both sectors and still favors Gomo- Badakhshan Autonomous Oblast (GBAO), the remote and mountainous region, which received 23 Somoni per capita-2.6 times the average per capita health spending for all other oblasts. Furthermore, budget planning and formulation are still based on the previous year's budget adjusted by inflation inboththe education and health sectors. As the previous year's budget was formulated based on norms such as the number o f workloads per teacher and number o f subjects taught (in education) and the number o f doctors per population, number o f hospital beds (in health), the norm based practice continues to affect the current annual budget inboth sectors. C. INTRASECTORAL EFFICIENCYANALYSISANDCHALLENGES 4.11 Intrasectoral efficiency measures in both sectors are based on two-step analysis: input- accesf (expenditure-immunization coverage in health and expenditure-gross enrollment rates in education) and access-output (immunization coverage-infant mortality in health and gross enrollment rates-literacy rate ineducation). The purpose o f this two-step approach i s to track the impact o f initial resources (inputs) on results (outputs) via an intermediate (access) step. This captures the effect o f other intermediate factors on which input-output may depend. In this sense, efficiency could be either technical or allocative.20 4.12 The key messages (supply and demand side) for policy makers are that, despite significant progress made over 2000-06, public spending in the health sector remains sluggish and Tajikistan i s far from achieving meaningful policy improvements in public spending efficiency. Tajikistan spends 30 percent more funds than most efficient IDA countries to achieve the same immunization rates. This indicates that improved efficiency could reduce its mortality rates by 4 percent. The main driver behind these improvementsis to ensure a strong link between development program objectives and public resource allocations. 4.13 Input efficiency (public spending across rayons) is uneven, which means some rayons consistently receive and spend more resources and attain relatively small efficiency improvements. Therefore, results for the subnational level paint a fairly mixedpicture. Indicators o f efficiency also changed unevenly. However, input efficiency (spending) remains relatively equal for all subnational service providers, while output efficiency (mortality rate) has a wider range. 20Technical eflciency (of spending as an input) shows whether the service providers are efficient and if they use more/lessinputsthanrequiredto obtaina given levelof output (andconsequentlyhow inputs couldbe minimized)- input efficiency or more output could be producedwith the same input - output efficiency.Allocative efficiency - shows that service providers use a sub-optimal input combination given input prices and corresponding productivities.Dueto data limitationonly technical efficiency analysiswas conductedfor Tajikistan. 34 Table 4.3: PublicSpendingon Educationand Health (excludingPIPfinancing) 2002 2003 2004 2005 2006 2007 Percentof GDP ("h) Education 2.6 2.4 2.7 3.5 3.5 3.7 Health 0.9 0.9 0.9 1.1 1.1 1.2 Percentof Total GovernmentExpenditure(YO) Education 13.5 12.3 13.1 15.8 19.3 Health 4.8 4.8 4.7 5.1 6.4 Spendingper capita (US$) Education 4.9 5.5 8.2 11.8 Health 1.7 2.1 2.9 3.8 4.5 In2000 ConstantPrices(Somoni) Education 78.4 101.0 134.2 193.9 Health 27.6 35.2 42.9 57.0 67.4 Source: Ministryof Finance, Republic of Tajikistan. 4.14 Local revenue collected by local (rayon, oblast) governments is not always appropriated back into the budget. This creates opportunities for excessive discretionary power at the local government level and so jeopardizes ongoing tax administration reform. The process o f revenue (re)distribution is comprehensively outlined in the annual Law on State Budget, which also provides incentives21to underestimate revenue forecast at the end o f the fiscal year.22(see table 4.4). 4.15 Intersectoral public expenditure planning i s not formulated properly by the central government during the fiscal year. In particular, in-year budget revisions or amendments have been common practices in Tajikistan. The 2007, the Public Expenditure and Financial Accountability assessment found that budget revisions were mostly upward because revenue collections were better than originally forecast due to conservative forecasts o f GDP growth and other indicators. The MOF also relies heavily on in-year government resolutions and/or presidential decrees, which would necessarily require allocation o f additional resources for ongoing or new investment and development projects. Since sectoral ministries usually do not receive their final figures at the beginning of the fiscal year and there are budget amendments during the year, health facilities and educational institutions find it difficult to plan their respective spending ranges. This leads to suboptimal use o f available resources, such as allocating but not always delivering results. This is a serious issue mostly inrural areas. 21Article 17 of the Law on Budget System and Process (2002) stated that revenues received in excess of budget projections as well as any excess of local revenues over local expenditures resulting from "saving" in planned expenditures are retained by the local councils and will be spent at the discretion of local executives in cities and rayons.Additional revenuehas no impact on the amount of subventionsor subsidies. ''Tajikistan:Public Expenditure andFinancialAccountability Assessment -PerformanceReport, SECO and World Bank, June 2007, p. 23. 35 Table 4.4: Comparisonof OriginalBudgetedand ActualExpenditureinHealthand Education, 2005-07 2005 2007 Expenditure CategoryLSeciot Plan Actual Plan Actual Total expenditureineducation,w/o PIP andEBF* (mln Somoni) 244.8 253.1 428.5 437.2 of which; wages and salaries (mlnSomoni) 139.2 137.9 237.1 246.1 Total sector expenditurefor education(mlnSomoni) 281.6 290.2 506.4 524.3 inpercent of GDP 3.9 4.0 5.3 4.1 Total expenditureinhealth, w/o PIPandEBF(mln Somoni) 89.3 82.4 131.0 145.3 ofwhich: wages and salaries (mlnSomoni) 29.9 29.0 51.2 51.2 Total sector expenditurefor health(mlnSomoni) 97.2 90.4 178.3 164.9 inpercent of GDP 1.4 1.3 1.9 1.3 Source: State Treasury, Ministry of Finance. * Extrabudgetary funds, or special funds. 4.16 Other common expendituremanagement issues inboth sectors pose serious challenges to generating further efficiency gains from public resource allocations. For instance, health facilities and educational institutions, which receive funding through local budgetary channels, sometimes remain solely at the discretion o f the rayon and oblast level administrations. Funds can be reallocated after the budget i s approved, but there are restrictions. The majority of education and health facilities' nonwage expenditures are paid mostly in kind. This helps to perpetuate discretionary decision making at the local government level on allocation of budgetary resources, which leads to nonoptimal outcomes. Therefore, many health facilities report receiving very limited allocations, but further analysis is required to determine whether this is becausethe rayon keeps the majority of the resources for its own needs or because goods are mostly diverted for local officials' private gain. Additionally, despite increasing financing in the health and education sectors, their subsector budgets are sometimes left underexecuted, which leads to increased budget flexibility of rayons. This i s usually offset by the trend of rising budgets and gives rayons the scope to assume more present than future spending. Furthermore, some key players in the health system have little or no discretionary authority; hence, it is difficult to infer any output-based activity at the local government level, while it i s unclear how desired outcomes at the local and republican tiers are achieved. Last, control over public resources is very poor due to weak functioning monitoring system, and it i s likely there are leakages. This is exacerbated by the fact that the frontline providers who are the ultimate recipients o f these funds or inkindinputsdo not have approved budgets.23 4.17 The quality of services and service delivery outcomes (and outputs) have been affected by a number o f important sector-specific factors, including inadequate basic infrastructure and 23As indicatedearlier inthe Chapter,since most facilitiesreceive inputs(such as medicinesand food) inkindrather than in cash, monitoringthe use ofthese resourcesbecomesvery difficult. 36 lack o f qualified teachers; especially inrural areas, and availability o f other conditions necessary for targeted public service delivery. According to the 2006 poverty update, 15 percent o f doctors in the top quintile were absent, compared with 2 percent of doctors in the bottom quintile. In addition, only 50 percent o f health facilities had drugs in stock. 4.18 Potential efficiency barriers on the demand side of service delivery also include disconnection between the institutions responsible for policy design and for allocation o f expenditures, which undermines accountability and provides opportunities for the diversion o f resources. Sectoral ministries have limitedinvolvement inthe formulation o f their sector budgets both at the republican and local levels despite being responsible for education and health policy, respectively. Since the central government resources are channeled to either RFDs or CRHs, it i s difficult to hold the Ministry o f Education and Ministry o f Health accountable for the health outcomes. Last, the discretion o f local government in managing the health budget weakens transparency in the allocation o f health funds and increases the scope for diversion o f the allocated health funds for other activities. D. HEALTH PETS Introduction 4.19 The Tajikistan health PETS collected budget data at each level o f government through which public resources pass before reaching frontline providers such as hospitals and polyclinics. Analysis o f these findings allows us to better understand the strengths and weaknesses of the management o f the budget, human resources, and other (nonhuman resources) inputs - thus providinga stronger basis for proposing and designingreforms.24 4.20 The main findings resultingfrom the analysis o f the health PETS are as follows: The central and local governments spend too little on health care services. The budget is so poorly managed and executed that few resources reach frontline health care providers, leaving large parts o f the system barely functioning. High absenteeism among health personnel is needlessly exacerbated by the lack o f distribution o f existingstuvkus (compensatory work loads). Health personnel cannot effectively deliver services because o f the scarcity o f essential inputs such as drugs, medical supplies, and utilities. There is wide dispersion inthe availability of resources among oblasts, rayons, and rural-urbanareas that translates into an inequitabledistribution o fhealthcare. 24The Tajikistan health PETS is unlike most PETS since it does not focus on estimating a leakage rate. Rather its mainobjective is on identifyingwhich aspects ofthe budget system work andwhich are dysfunctional. 37 4.21 The PETS findings point to a fundamental challenge that will require significant commitment by the government to address. On the one hand, inadequate public resources are devoted to the health sector, and more are needed to reach even minimally acceptable standards o f care to the population. On the other hand, the existing public resources are so poorly spent that, without substantial changes, a large portion o f any additional resources channeled into the system will be wasted. Consequently, an increase inpublic resources to the health sector mustbe accompanied by significant reforms that may be difficult to implement given the competing interests o f sector stakeholders. 4.22 Coordination among the institutions responsible for health policy, financing, and service delivery i s weak. The M O H i s responsible for the development o f health care policy. It also provides guidelines to the oblast health departments regarding health priorities but does not provide oversight for subnational facilities.25 However, it i s the MOF that allocates the central government's funds for health care directly to the oblast administrations with little or no consultation with MOH. The oblasts health departments manage regional-level health facilities, but turn over the bulk o f resources to the rayon administrations, which in turn allocate the majority o f these resources to the Central Rayon Hospitals (CRH). The management o f most health services i s located within hospitals, with the chief doctor o f the CRH administering all health services (for example, rural clinics, polyclinics, disease prevention, and mother and child services) in the rayon. Consequently, the chief doctor acts both as the manager o f the CRH and head of the rayon health system (see Figure 4.2). 4.23 The CRH chief doctors have significant discretionary power and are de facto key decision makers in the distribution o f health resources. The majority o f the rayon's budget i s allocated to the CRH, which i s responsible for retaining some o f the funds for its operations and allocating the remainder among the other health facilities in the rayon. In particular, the chief doctor i s the person with the greatest authority in three important areas: (i)personnel management, including the allocation o f floating stavkas (compensated workloads); (ii) allocation o f in-kind resources (for example, medicines and medical supplies) to rayon health facilities; and (iii)reallocation o f budgetary funds from other health care services (such as polyclinics and public health affairs services) to hospital care. However, despite these responsibilities, there are few mechanisms inplace to ensure accountability o f the chief doctor to the oblast administration. 25Organizationalstructure should include Tajik Institute for Postgraduate Training of Medical Workers, Republican Medical College, Medical Service Control Bureau, and PharmaceuticalActivity Control Bureau. 38 Figure4.2: OrganizationalStructureof Government Health System Village,Community Source: Ministry ofHealth, Tajikistan. Figure4.3: PublicHealthExpenditures by Figure4.4: Share ofFacilitiesReceivingFunds Category in YOof Goods and ServicesExpenses or In-Kind Inputs,in YOof TotalFacilities 120 1 100 100 80 60 40 20 0 Labor Drugs Food Fuel Other Source: Government of Tajikistan. Source: HealthPETS, 2006. Notes: This figure excludesexpenditureson labor."Other" Notes: "Other" refers to other goods and services such as refersto other goods and services such as stationaryand stationary and materials. materials."Repairs" refer to repairs and maintenance. 39 Allocationof PublicResources 4.24 Public spending on health care services, especially nonhospital services, i s low in Tajikistan. In 2005, public spending on health was an estimated 1.1 percent o f GDP, which is low but comparable with the average for low-income countries. To compensate for the overall low level o f public funding and inefficient spending, the Tajik population makes out-of-pocket expenditures estimated at 3 percent o f GDP. Republican (central government) health spending accounted for about 24 percent o f total health expenditure, as opposedto local health spendingof 76 percent o f the total in 2005. An estimated 65 percent o f total public health expenditures was spent on hospitals, and the rest was distributed to polyclinics, public health, and miscellaneous categories. This distribution o f resources to hospitals sustains the oversized - yet underutilized - network o f hospitals inTajikistan at the expense o f less expensive (yet equally effective) primary care and public health services. 4.25 Only 35 percent o f the facilities surveyed by the PETS reported preparing a budget in 2005. Republican and oblast-level facilities have separate budgets, while primary health care facilities do not have their own separate budgets approved. Thus, tracking facilities' expenditures i s not feasible, as they lacked information regarding funding allocated to them. It was a convention that a CRH and in some cases jamoat (lowest level of local government) administration provided health facilities o f a particular rayon with in-kinds inputs the financing o f which was a part o f consolidated CRH andjamoat budgets. HealthCarePersonnel 4.26 Tajikistan's health workers consider themselves grossly underpaid and employ coping strategies, some of which are illegal. The average salary rated "fair" is 7.7 times higher than the actual average salary. Inorder to compensate for the low salary, many health workers either seek employment outside the facility or informally charge patients. Approximately 18 percent o f the health workers admit that they work outside the facility to supplement their low income. On average, health sector employees worked 20 hours per week in a secondjob, which may explain the high absentee rates seen in Tajikistan (estimated at 30 percent o f health workers at any given time). Furthermore, besides working outside the facility, 46 percent o f the health workers admit to receiving informal payments (gifts in cash or in kind) from patients to supplement their income. 4.27 Stavkas are one mechanism available for increasing health workers' income, yet many are unallocated, which results inunderspending o f the labor component o f the health budget.The chief doctor o f the Central Rayon Hospital i s responsible for allocating stavkas to health personnel, which means significant power over human resource decisions as well as over the budgetallocations for wages and salaries inthe health sector. Moreover, higher salaries andmore stavkas reduce substantially the likelihood o f a health worker's being absent. Despite this, PETS findings show that the average facility has 13 extra stavkas, ofwhich only 8 were redistributedto the employees. 40 4.28 Many facilities do not receive essential inputs or services, while large allocations are made to certain categories. In2005, 43 percent o f total public health expenditureswas allocated to labor compensation and contributions. The remainder was distributed among medicine, food, fuel, communal services, and repairs and maintenance, as seen in Figure 4.3. The categories o f food and other goods and services (such as stationary and other materials) constitute almost 40 percent o f total non-labor related current expenditures. The concern arises that these inputs can be easily divertedfor private consumption. O f equal concern is that only 61 percent of facilities survey reported receiving funds for drugs or actual drugs (see Figure 4.4). A significant share of facilities - 16percent o f all facilities surveyed - reported receiving no funds or in-kindresources from government sources in2005. Table4.5: Availability of CommunalServicesinHealthFacilities Urban Rural Tajikistan (Average no. of hours per day) a Electricity availability inwinter period 19 6 9 Heating availability inwinter period 12 4 5 (% of facilities with access) Access to piped water 95 29 41 Access to communications(phone or radio) 85 9 23 Access to transportationvehicles 48 12 19 Source:TajikistanHealthPETS 2006. a. "Day"refersto 24 hours. 4.29 Many health facilities - especially in rural areas - appear to be barely functional. Table 4.5 indicates the scarcity of key "communal" services (utilities, transportation, and communications) available to health facilities inTajikistan. The situation i s much worse inrural versus urban areas and in nonhospital facilities versus hospitals. For example, only 29 percent o f rural health facilities have access to piped water (either inside or outside o f the facility). In winter, rural health facilities have an average o f 4 hours o f heat (usually from burning coal) per 24 hours. However, despite this dismal situation, rural health facilities may be the only viable health care option for the population in a country where access to superior urban health care i s hampered by distances, mountainous terrain, an underdeveloped road system, and costly transportation to urbancenters. 41 RegionalDistribution 4.30 Resource allocation in the health sector varies across the regions. On a per capita basis, some oblasts receive more health care hnds than others, as seen in Table 4.6. For example, GBAO received SM 23 per capita, which was 2.6 times the average per capita health spending for all oblasts. It i s not clear whether this reflects the higher cost of providing the same level and types o f goods and services to GBAO, which is a mountainous region, or a greater proportion o f goods and services being provided to the residents o f this small oblast relative to other oblasts. Also, within the oblast (as opposed to across oblasts), resource allocation per capita was not correlated at the rayon level with income per capita. Hence, poorer rayons did not receive more money. 4.31 The structure o f health spending- also Table 4.6: Public Expenditures on Health by Oblast, 2005 differs across oblasts. Dushanbe The oblasts allocated & RRS Khatlon GBAO Sugd Tajikistan their resources (in percent of oblastpublic health expenditures) differently across Hospitals 50 71 78 72 78 various types o f health Polyclinics 28 15 10 22 11 expenditures (hospitals, Public health 5 11 8 6 6 polyclinics, public Other 17 3 5 1 5 health. and other health (in somoni) services, as seen in Health 8.81 7.87 23.35 9.22 9.05 Table 4.6). Hostital expenditures/capita ..I. affairs and services Source: ruovernrnent OK Iajilcisran. .I .*-I-..I received the largest proportion o f health expenditures, averaging 78 percent for Tajikistan. Dushanbeand regionsunder Republican Subordination(RRS) allocated the most proportionately to polyclinic affairs and services at 28 percent, compared with 11 percent o f total public health expenditures for Tajikistan. This variation in allocation needs to be understood to determine to what degree this reflects the needs o f the oblast's populations or whether these spendingpatterns are a result of some other reason, such as previously established spending patterns or discretionary powers o fthe rayon. 4.32 The National Immunization Program suffers from many of the same resource allocation and public expenditure management issues as primary health care services. Immunization resources are not allocated on the basis o f improving equity among regions or rayons, improving performance, or meeting target population needs. The lack o f explicit requirements creates an environment whereby decision makers can have significant discretionary power without concomitant oversight and accountability in allocation and use of funds. Financing for the NIP is fragmented and highly centralized, with a large share o f government resources (40 percent) concentrated at the Republic Center for Immunoprophylaxis (RepCI), allocated to hospitals, or the Dushanbe region. There i s significant underfunding o f immunization services at the facility level. The mean total requirement for immunization 42 activities for the facility sample in2005 was S2,079 (US$603), which i s more than four times the level o f government resources (in-kindand budget) allocated to primary health facilities. At the facility level, voluntary payments by staff (contributions) represent a significant source of financing for immunization activities, such as supervision, outreach, and vaccine collection. Financing o f the NIP increased 142 percent between 2001 and 2005 to approximately US$1.5 million, or US$0.22 per capita, but 97 percent o f funding comes from external donors. Sustainability and predictability o f financing o f the current program remain major issues. Policy discussions resulting in greater government allocations for vaccines were a benefit o f including an immunizationmodule inthe Health PETS. E.EDUCATION PETS 4.33 This discussion emerges from the findings ofthe 2007 public expenditure tracking survey (PETS). The PETS itself was a response to important trends that threatened increased pressure on the public education sector: (i)rising expenditures under increased pressure resulting from growth in student body size and deteriorating infrastructure, (ii)demonstrated inequalities in public education funding, and (iii)absence o f efficiency gains. The PETS was conducted to assess potential efficiency gains by, for example, identifying sources o f public fund leakage. Collected at the rayon, jamoat, and school levels (where possible), its data are highly disaggregatedand so can be used both to check the accuracy o f the education financing system and to test whether funds allocated to education are reaching schools. To that end, researchers conducted a "triangulation" exercise that compared budgets from different levels o f the hierarchy. Since most public education expenditures are allocated to general education, primarily to wages and salaries, the PETS explored how improved deployment o f staffing resources might generate efficiency gains. Finally, the PETS questionnaire attempted to address, inthe Tajik context, the issue o f equity of expenditures and the state of school infrastructure in the country. 4.34 A summary o f the PETS findings includes the following points regarding the general education system. Resource management features a highlevel o f local discretion characterized by strong formal accountability down to the rayon or jamoat level. The M O E controls education policy nationwide. However, lines o f financial accountability runnot to the MOE, but from schools and jamoats up through rayons and oblasts (where applicable) to the MOF. Not all schools are subject to jamoats: whereas rural schools are supplied with goods, services, and nonteaching staff salaries by jamoats, city and town schools are not under jamoat jurisdiction, but are supplied directly by the rayon. Local governments execute the general education budget; rayon governments in particular enjoy discretionary power inallocating resources within the education sector. Rayons must use funds under the "protected" budget lines, including salaries and utilities, within the economic classifications stipulated, but they have discretion to determine the allocation ofthese amongjamoats and schools. There is also a "lump sum" budget 43 allocation for all the nonprotected lines, which rayons can allocate at their discretion among both economic classifications and jamoats and town schools. Revenue i s collected at the local level, but some rayons are also "subsidized" with funds from the center. Whenrayons collect more revenue than anticipated, or when there are unspent funds left over from the previous year, they have more discretion as to how to spend these than other funds. Since budget cuts may take place at each stage inthe approval process, the system has a bias in favor o f the budget lines that are "protected" from such cuts, especially salaries, as opposed to goods and services. Recordkeeping and control o f funds exist in the rayons but not at the stage o f the budget process where goods and services are distributed, usually by jamoats, to schools. Budget processes appear highly accurate and consistent down to the jamoat level, but from the jamoat level down, the picture i s less clear. Jamoat accounting processes do not carry adequate financial accountability down to the schools. The main problem with the jamoats i s not failure to execute their responsibilities, but rather the process by which their responsibilities are defined. Jamoats are not expected to keep track of how funds are allocated among schools. This i s harmful both to "top-down" and "bottom-up" transparency. It becomes difficult, even impossible, to track public resources all the way to their final destination in the schools. Moreover, schools do not know, at least not formally, what they will get from the jamoat. Although some jamoats and schools keep records, jamoat accountants and school zavkhozy (resource managers) were not able to reconstruct and reconcile, usingthese records, accounts of what was allocated to and received by schools. 4.35 In other countries, PETS have been useful tools for documenting levels of leakage, especially o f nonwage funding, merely by comparing records at the school level with records at other levels o f the hierarchy. However, in the Tajik case, the inadequacy o f records makes it impossible to calculate the amount and value o f resources transferred from jamoats to schools or to reconcile what jamoats report allocating with what schools report receiving. Some budget lines show jamoats reporting more deliveries o f supplies than schools report receiving; others show the reverse (see Table 4.7). On average, jamoats report more allocations to stationery, inventory, toilet cleaning, and water, while schools report more electricity, heating, paint, and lime. At the same time, the supply of nonwage inputs to schools is limited. Most schools reported no deliveries o f stationery and inventory. Only a small minority o f schools reported receiving basic maintenance materials like paint (19 percent of schools) and lime (17 percent). Even heating fuel, the most commonly delivered item, was not received in all schools, and those that received it typically reported that it was insufficient for their needs. 44 Table4.7: Jamoat Allocations to Schools (4 (2) (3) (4) (5) (6) (7) Budget category Share of schools (99) for Share of schools (%)for Average money value which ajamoat which a money value of (Somoni, 2006) where allocation or delivery is goods and services reported, accordingto: reported by: allocated is reported by: Jamoat School Jamoat School Jamoat School Stationery 47.1 32.8 93.7 82.8 157 154 Economic 44.6 39.4 93.1 65.5 307 251 expendituresand inventory Sportsgoods 1.2 1.2 100.0 100.0 50 50 Electricity 78.7 90.8 39.2 15.4 336 303 Gas 3.5 2.6 56.7 76.0 871 871 Heating-Total 65.6 79.8 97.1 55.5 970 656 olw :Coal (including 53.6 51.8 88.1 43.4 916 758 transportation) olw :Wood 31.7 41.1 81.5 82.8 571 453 (including transportation) olw : Other fuel 1.7 2.6 100.0 41.0 293 332 Trash pick up 3.8 4.7 100.0 43.9 208 224 Toilet cleaning 1.2 1.6 100.0 77.0 168 185 Water 10.4 8.4 92.2 21.9 288 263 Buildingrepair- Total 16.3 20.1 100.0 80.4 1,833 1,505 olw: Paint 18.8 18.9 89.8 84.4 250 257 olw: Lime 15.9 16.6 88.0 81.2 145 124 olw: Other repair 9.1 10.2 100.0 90.6 576 722 works or construction material [11 olw: Other repair 4.9 5.7 91.1 100.0 1,466 266 works or construction material [2] Communication 13.4 6.0 100.0 49.4 42 109 services Construction, 1.o 3.3 100.0 68.2 817 25 reconstruction, Purchase oftechnical 0.3 0.0 100.0 2,457 equipment-Total olw: Desks 1.4 100.0 7,749 olw: Bookcases 2.6 100.0 240 170 olw: Tables 11.0 100.0 280 olw: Chairs 11.0 100.0 140 other equipment and 0.0 inventory, indicate other equipment and 0.0 inventory Source: PETS Education data, 2007. 45 4.36 Data on the subset o f schools financed on a per capita basis show a high degree of consistency among budgets at all levels. Traditionally, schools know little or nothing about their budgets and have little say in what goods and services they receive. This i s not the case for schools inper capita-financed (PCF) rayons, where the jamoat no longer plays a role and schools know their own budgets and can report how they are executed. The PCF approach-introduced in 5 rayons in 2005, expanded currently to a total of 17 rayons, with nationwide expansion planned-was intended to give more leverage to school administrators in the use o f resources allocated to them, thereby leadingto efficiency, equity, and transparency gains. According to this system, a school's annual financing i s calculated from the Rayon or the City Education Department (RED/CED) budget for recurrent expenditure according to a formula that takes into account factors such as the total amount o f funds available for education in the rayodtown budget and the agreed plannedenrollment statistics o f a school. 4.37 The allocation o f resources for recurrent expenditures for PCF schools i s different from that in non-PCF schools: once the formula i s used to calculate the resources available to each school, schools are informed o f the amount available to them and manage it according to their needs. There i s an attempt at assuring equity, since the formula supplies schools with funds proportionate to the number o f students. There are also incentives to manage money efficiently, because (i)decision making i s located in schools, which have the best information, and (ii) schools face budget constraints and can reallocate across expenditure categories. The availability o f budgets in schools also opens the door to greater civil society participation in substantive school decisions and provides an extra safeguard against leakage and corruption, since parents can examine the budget and make sure it i s beingused appropriately. 4.38 One expected efficiency gain from implementation o f per capita finance o f education was the consolidation of classes, which would inturn reduce the total number o f teaching hours, and therefore the amount of salaries paid to teachers. Under the traditional financing system, it would not be advantageous for schools to do this, because any money saved would revert to the local budget. Yet in terms of deployment of staffing resources, Tajik schools generally have reasonable student-teacher ratios and teacher workloads. However, teaching hours vary widely (see Table 4.8), and while most teachers are`satisfied with the hours they teach, about one- quarter to one-third would like to teach more, which may create pressures for class splitting. On average, class sizes are probably smaller than optimal, but there is notable variation across schools and regions. However, decisions on class sizes do not follow strictly the standard rule that classes in grades 1-4 should have at most 25 pupils, and grades 5-11 at most 30. Instead, class-splitting decisions are subject to local discretion and sometimes result in "too few," sometimes "too many," classes per grade, relative to the rule. In total, however, the number o f classes in the country does not differ greatly from the number that would be predicted if the standardrule were strictly applied. 46 Table 4.8: RegionalVariationin School Size, TeachingHours,Pupil-TeacherRatios,and Class Size Average school size Average Pupil-teacher Average class Oblast (number ofpupils) teachinghours ratio size Dushanbe 1,658 26.5 26.0 27.6 RFe 510 23.8 17.6 19.5 Khatlon 452 25.0 18.7 18.4 Sogd 423 20.4 12.4 17.3 Gbao 251 18.4 10.8 15.6 Total 476 23.O 16.4 18.4 Source: PETS Educationdate, 2007. 4.39 The composition o f PCF and non-PCF school budgets is similar. N o budget category differs by more than a few percentage points between them. Either PCF schools have not deemed it advantageous to make dramatic changes inbudget composition, or they have not had time to do so. Inparticular, the largest categories, salaries and social insurance, have not been reduced as a share o f the budget. In other words, although PCF schools consolidate classes, this has not led to a reduction inthe wage bill as a share o f the total budget. Instead, the main source o f savings inPCF schools appears to be utilities, especially heating and garbage removal. Inaddition, PCF schools spend a larger share o f the budget on purchases o f several types o f goods and services. They spend almost twice as much on stationery, half again as much on inventory, and more than twice as much on travel expenses (possibly because, with greater responsibilities for procurement and money management, school administrators have more needto travel). 4.40 Tajikistan's rising student population will require ongoing capital investment if its needs are to be met. School buildings are used intensively (96 percent o f schools operate in two or three shifts), and 49 percent o f school principals reported that their school experienced overfull classes (with variation across oblasts). One o f the options available to principals is, o f course, to split classes in order to reduce their size. However, 85 percent o f principals who reported overfull classes said that lack of classrooms was an obstacle to class splitting, and 54 percent cited lack o f teachers. Inaddition, capital renovations are rare: duringthe last five years, only 14 percent o f school principals reported that a capital renovation was undertaken, and 72 percent reported that there had not been any capital renovation in the school since it had been built. Capital renovations are more likely to be undertaken in urban than in rural areas: 40 percent of principals from urban areas, compared with 24 percent from rural areas, reported that a capital renovation was undertaken. The PETS sample reflects conditions at schools that had been surveyed in 2004, and comparative results raise the concern that poor facilities increased substantially relative to other problems schools face between 2004 and 2007 (see Table 4.9). 47 4.41 The current state Of affairs indicates disparities in public per Table 4.9: ProportionofPrincipalsthat ReportedProblems (percent) student funding as well as variation problem 2004 (EFS) 2007 (PETS) in the extrabudgetary funding that Shortageof teachers 56.0 54.4 schools receive. Thus, generally regions with larger schools spend of teachers 38.4 49.3 less per student. A second pattern Poor infrastructure 25.5 47.9 observed is that schools o f any size Inadequatesupplies 50.6 66.2 in the more prosperous No heating of classrooms 63.3 49.7 unsubsidized rayons are better Source: EducationFacilities Survey (2004) andPETS (2007). funded than schools in subsidized rayons. A third pattern relates to PCF schools, which exhibit the highest levels o f per student finding regardless of school size. This finding probably resulted from the design of the per capita finance pilots, which sought to have no immediate adverse impact on schools' budgets, which would create losers and thus opponents to the financing reform. On the other hand, while PCF schools exhibit the highest per student public expenditures, extrabudgetary transfers are especially frequent among non-PCF schools. According to principals, more thantwo-thirds o f all schools received at least one such transfer in 2006. Schools under the PCF system generally receive the resources budgetedfor them and are less inneed o f additional resources than schools under the traditional financing scheme. This might explain why only 52 percent o f PCF schools received such a transfer, compared to 71 percent o f schools under the traditional financing scheme. Transfers are also less frequent in Dushanbe and Sogd than in the other oblasts, and especially frequent in GBAO. Students' parents are the most frequent source o f extrabudgetary transfers, and the lion's share o f their contributions i s dedicated to school renovation and construction materials. This underscores the importance o f improving school infrastructure, particularly for the poorer segments o f the population. 48 5. CONCLUSIONAND POLICY RECOMMENDATIONS 5.1 The analysis and findings inthe PPER, summarized above, are intended to contribute to the policy dialogue in Tajikistan. In some cases, clear policy recommendations can be drawn from the analysis. The immediate policy priority for government should be to restore sound macroeconomic management, to avoid any further deterioration o f macroeconomic performance and avert a potential balance of payments crisis. This will require dampening the growth of aggregate demand to reduce internal and external imbalances, rebuilding international reserves, and curbing the growth o f external public debt. 5.2 The key macroeconomic policy reforms requiredare: Sharplyreducing money supply growth. 0 Rebuildingthe NBT's foreign exchange reserves, which will almost certainly require a managed depreciation of the exchange rate. Supporting the reduction o f money supply growth and the rebuilding o f reserves; government domestic financing should be negative, which in turn requires fiscal consolidation. 0 Enforcing legal constraints on the authority o f the NBT and other parastatals to contract or guarantee external debt. 0 Enforcing strict annual limits on new external borrowing, calibrated to bring the external debt indicators back down to the thresholds at which debt i s regarded as sustainable. 0 Prohibiting nonconcessional external public borrowing. 5.3 The electricity sector will play a prominent role inthe future growth and development o f Tajikistan, given that the economy enjoys a strong comparative advantage in the hydropower generation. The scale o f capital investments required to develop the industry is enormous and hence it i s essential to attract private investment. Government has a key role to play: in regulating private investment, reforming the domestic electricity market, contributing to the investments costs o f essential transmission infrastructure to export markets, and, almost certainly, as a minority shareholder in new production capacity. While there are potential substantial fiscal benefits to be gained from development o f the industry, there are also risks which could jeopardize the long-run sustainability of public finances. To mitigate the risks, government should: Raise the average domestic tariff to the long-run incremental cost o f supply, a measure that i s essential to eliminate the quasi-fiscal deficit inthe electricity sector. Minimize its own contributions to the capital costs o f new generation projects and avoid finding these contributions with commercial debt. Minimize the extent to which Barki Tajik guarantees purchases o f power from generators which i s destined for export markets. 5.4 Public financial management reforms are a prerequisite for improving the efficiency o f public expenditure. The government has begun to make progress, especially in respect of the introduction o f PBB, where the education sector i s piloting the implementation of the MTEF. But the PFMreformagenda is large and very challenging. Key priorities inthe medium term are: 0 To continue implementation o f the MTEF, strengthening budget planning capacities inthe MOEand gradually bringingnew sectors into the MTEF. 0 Revisebudget classification and integrate it with the Chart o fAccounts. Set up an independent external audit organization. 0 Establish targets for adoption o f IPSAS accounting and reporting standards. 0 Put inplace a framework for internal auditing. 5.5 The heath status and educational attainments of the Tajik population have deteriorated since the country gained independence, mainly because the government has been unable to afford the costly health and educational systems inherited at independence and because it has failed to implement reforms that would achieve a better allocation o f scarce budgetary resources in these sectors to improve allocative efficiency. Instead resources are poorly allocated, with overemphasis on centralized, capital-intensive, and tertiary services at the expense o f decentralize primary health and education. Budget management i s impeded by the fragmentation o f responsibility for spendingpublic finds in these two sectors between a plethora of different institutions at central and local government level. The key reform priorities in the health and education sectors are: Steadily increase budget resources to these sectors over the mediumto long term. 0 Align moreclosely budgetallocations with clearly defined sector policy objectives. 50 0 Improve the coordination in budget planning and implementation among the various institutions responsible for public spending in these sectors. Ensure that the sector ministrytakes the leadingrole indetermining budget allocations. 5.6 This report argues that, given Tajikistan's narrow economic base, the government cannot afford ambitious and expensive infrastructure or social development programs. A sequencing strategy for government development projects i s essential with a sustainable debt strategy given the "high debt distress" Tajikistan currently faces. In addition, under that circumstance, it becomes essential to spend wisely and efficiently and to optimize technical capacity and efficiency. These can combine to allow Tajikistan to fulfill its potential for increased economic growth, reduced poverty, improved mortality and enrollment rates, as well as other benchmarks o f sound policy and practice inall critical sectors. 51