Tajikistan

/379' Ta jikis tan H1 A W O R L D B A N K C O U N T R Y S T U D Y  A W OR L D B AN K CO UN TRY STUDY Tajikis tan The World Bank Washington, D.C.  Copyright 0 1994 The International Bank for Reconstruction and DevelopmentITHE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. AlI rights reserved Manufactued in the United States of America First printing Novcmber 1994 Wodd Bank Country Studies are among the many reports originally prepared for internal use as part of the continuing analysis by the Bank of the economic and related conditions of its developing member countries and of its dialogues with the governments. Some of the reports are published in this seres with the least possible delay for the use of governments and the academic, business and financial, and development commu- nities. 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ISBN: 0-8213-3105-1 Library of Congress Cataloglng-iln-Publication Data Tajikistan p. cm.r-(AWorld Bank country study) "The economic report was prepared by Reza Ghasmi (main author) . . and others" ISBN 04213-3105-1 1. Tajikistan-Economic conditons. 2. Tajikistan-Economic policy. 3. Post-communism-Economic aspects-Tajikistan- I. Ghasimi, Reza. II. Intemational Bank for Reconstruction and Development Im. Series. HC421 .3.T35 1994 33.958'6-dc20 94-40254 CIP  m CONTENTS PREFACE ............................................... vil ABBREVIATIONS ............*.....*........... CURRENCY.EQUIVAL ..*................. .................... x EXECTYXVE SKM3VIARY ............................. i THlE MACROECONOMIC FRAMiEWORK . .............................. . I CHlAPTER 1: Background and Recent Econonmc Derdopmens ................ 3 CHAFFER 2: Econodc Reforms and Externl FIuancing Req rments .... W... is THE AGEND A FO R REFOR. ........................... 27 CHAPTER 3: Enterprise Reonr and Private Sector Developm en t............. 29 CHAPPTER 4: The Financi Sect ................................ . 53 CIAPrFER 5: TradeRegim ................ ............, 69 CHAPTER 6: TheSocidlSector .................................. 77 SECrORAL TRANSFORMATION ........*............. .... .. 93 CHLAPTE.R 7:. Agricultmral Sector . ........... ......... ........ 95 CHAFPER 8: Industry and Blin Secto ............ ............ . 111 CIAPrER 9 TheEnergy Sector .... ....... .................. 11 CHAPTER 10: n ttr ............... ... ... .......... 147 CHAPIER 11: Invetment in Human Capital .......... . ....... ..... 169 CHAI'ER 12: EUviranuF It .... ...... ....... . ............... ... 183 STATPL CAL APPEYIX ................... 193 MAP  iv Tabls 1.1 Re GrowthinNet Maial Product ............................ 4 1.2 National AccontsSummary .................................. 5 1.3 StaeBudget, 1991-93 ...................................... & 1.4 Man Monetury Aggegates ................................... 10 1.5 List of Main Consumer Products and Services Subject to State Price Regulation ......................................... 11 1.6 Monthly Changes in Retail and Wholesale Prices ..................... 12 1.7 International Trade, 1991-93 ................................. 12 1.8 BalanceofPayments ...................................... 13 2.1 Projectionof Key Economic Indicators .......................... 19 2.2 Medium-Term Pojections: External Fincing Requirements .... ........ 21 2.3 Creditworthiness and Required Concessionaity ..................... 24 3.1 IndustryStruictsre,1992 .................................... 32 3.2 Medium and Large Republican Enterprises to be Privatized in 1993-1995..... 33 3.3 Medium and Lare Priratizatbn Accomplishments, as of October 1993 ...... 35 3.4 Small State Businesses, Cooperatives and Private eris ............E. 45 3.5 Self-Employed Persons ............................... 46 3.6 Foreign-Owned Companies, 1991-93 ............................ 49 3.7 Sources of Foreign nvestmnt, Joint Venturs, October13 ............. 50 4.1 TajikBanks ........................................... 55 4.2 Bak Assets and Funding from Ceral Sources ..................... 56 4.3 InteestRates .......................................... 57 4.4 htr-enterprise Arrears by Bark . .............................. 60 4.5 Inter-enterprise Arrears by Selected S. . rs......................... 61 4.6 Seected Short Term Credit, Growth by Catgory .................... 61 4.7 Lending by Naional Bank of Tajikistan, end September 1993 .......... 62 4.8 Loan ArrearsbyBank ..................................... 63 5.1 The Cearing Arrangement with Russia .......................... 70 6.1 Comparative Social Statistics . ................................ 77 6.2 Minimum Food Basket Composition for Poor Families . .78 6.3 Population Distribution by Family Size and Rural/Urban . .79 6.4 Sources of Family Income by Lvel of Per Capita Income Pcet - 1989 81 6.5 Social Protection Payments as Percent of NWP, GDP and Budget Expendiures ............. 82 6.6 Composition of Pension Fund Beneficiaries ........................ 83 6.7 PensionFundBudgcts .................................... 84 6.8 Employment by Sector, 1980-92 . ............................. 87 8.1 Gowth in Fixed Assets by Subsector ........................... 113 8.2 Aggregate Financial Position of Industry Sector .............. 114  V 8.3 Batk Credit by Industry Subsector ............................. 115 8.4 Non-State Owned Enterprises ............................. . .117 8.5 Silver Mines & Deposits ................................... 121 8.6 Coal Deposits .......................................... 122 8.7 Gold Mines adDeposits .. 123 9.1 Energy Balance .131 9.2 Energy Trade .133 9.3 Energy Prices .134 9.4 Imports of Oil Products .135 9.5 Generation Facilities in Tajildstan .136 9.6 Energy Supply-Demand and Trade Outlook .140 9.7 Oil, Gas and Coal Production .141 10.1 Telephone Service Quality - Selected Indicators .158 10.2 Summary of Telephone Tariffs ................................ 159 10.3 Summary of Financial Results, MOC - All Sevics ................... 160 11.1 InfantMortadity Rates ..................................... 170 11.2 Cuses of Infant Mortality .171.... 171 11.3 Matenal Mortaity Rates .................................. 172 11.4 Social Sector Spending - Percent of Budget .173 11.5 StudentTeacher Ratio .174 11.6 AverageClass e ....................................... 175 11.7 Salary andBenefits a ShareofSectorBudgets .177 1.1 Main Macroeconomic Indicators ...... ,.. 3 1.2 Retai and Wholesale Pice Index .11 1.3 Structure of Exports, 1990 .13 1.4 Structure of imports, 1990 .13 5.1 Trade and Supply Contacts .74 7.1 Land Use by Category ..................................... 95 7.2 Value of Agricultural Production .95 7.3 LandUse byType of Organization ............................ 96 8.1 Industry Structure, 1992 .11 8.2 Industry Trend, Output Index ................................ 112 8.3 Age of Equipment, as of 1988 ............................... 114 8.4 Industry Cost Structure ...1..5.... .... ,. .... : ....l15 11.1 Tajikistan Education System ................................. 174  vi Boxes 2.1 Tajikistan Emergency Reconstruction Program . ..................... 22 3.1 Leg F ramework in a Market Eco ynM .......................... 30 32 Privatization Accomplishments ................................ 34 3.3 Privatizaion Decision Process .36 3.4 Small-Scale Privatization Experience in Eastern and Central Europe .37 3.5 Aziz aothing Store, Dushanbe: A Success Story .38 3.6 Bottom-up/Top-downApproach .39 3.7 Technical AssisceinPrivatsizatin... 51 4.1 A DescriptionofdieLargerTajikBan. .58 4.2 PrudentialRegulatiou ofNBT .63 4.3 Technical Assistance in the Financial Sector .65 5.1 TheStateOrderSystem .................................... 72 6.1 Summary Data . 80 6.2 Social Protection: Insitdons .... 82 7.1 Visitto aCobonGin................... ................... tO0 7.2 Central Asian Water Resourcem iagement .....M............ ... 105 7.3 Technical Assistance in Agriculture ........... 108 8.1 jor Industry Subsectors ........... 112 8.2 Enterpris Sectr Orgniaton and Managemnt ........... 116 8.3 The Aluminum Industry ........... 120 8.4 Regional Mers Profile ........... 121 8.5 Todical Assismc in the Industrial Seor ........... 128 9.1 Tajikn Enery ........... 138 9.2 Technical Assistae in the EnergySeo ............ 143 10.1 Technical Assistc Needs in tbe lnfisuctumrSector .164  vii PREFACE This report is based on fndings of a World Bank missions to Tajidsta in October 1993 led by Peza Gbasimi. The World Bank wishes to thank the authorities of Tajildstan for their hospitlitr, support and excellent cooperation. The Economic Report was prepared by Rem GObsimi (main autbor), Jamal Saghir and Lueja Swiakowski (Privatization), Cevdet Denizer (Macoeomics), Hong Wet ad Barra Ossowidca (Statistics), Per Sdireiner (Trade), Radwan Al-rid (Legal Framework), David Wilton (Financial Sector), David Kunkel (Agriculture), Ruth Klinov-Halul and Meskeem Mulau (Social Sector), Michael Levitsky (Energy), Ranjan Sengupta (ndustry and Mini, Jean Charles Crochet (Transport), Eloy Vidal and Ejorn Wellenius (Telecommunicatiou) and Sherry Login (Envionmment). Valuable comments were provided by Isabel Guerro, Costas Michalopoulos, and Laura Tuck Halch Bridi provided continus support The report was processed by Cielito Pelegrin. The work was carried out under the general spervision of Kadir Tanju Yurukoglu, Division Chief, and Russell J. Chktham, Director.  ix ABBREVIATIONS ACU Aid Coordination Unit CAR Central Asian Railways CBR Central Bank of Russia CMEA Council for Mutual Economic Assistance DTCS Department of Transport and Commercial Services EAMU Extermal Assistance Management Unit EBRD European Bank for Reconstruction and Developmnt EC Employment Center ETA Environmental Impact Assessment FDI Foreign Direct Investment FSU Former Soviet Union GAAP Generally Accepted Accounting Principles GDP Gross Dom-estic Product GMP Good Manufacturing Practices GNP Gross National Product IBRD Inernational Bank for Reconsn and Dev dpmt IMF Iternatonal Monetary Fund MOA Ministry of Agricultr MOC Mnistry of Communications MOE Ministry of Education MOF Ministry of Finance MOH Ministry of Health MOH Ministry of Highways MORT Ministry of Road and Travel MPC Maximum Poilutant Concentatio MTMR Ministry of Trade and Material Resources NBT National Bank of Tajikistan NGO Non-govemmental Organization NMP Net Material Product PF Pension Fund S/C State and Collective SIF Social Insurance Fund SOE State Owned Enterprise SPC State Property Committee STF Systemic Transformadon Facility TBB Taj Bank Business TRACECA TraWort Comdor Europe Central Asia UNICEF United Nations Childrens Fund VAT Value Added Tax WHO World Health Organizaton  K CURRENCY EQUIVALENTS CURRENCY UNIT = RUBLE Excag Rat 1992 January 110 February 103 March 93 April 100 May 94 June 89 July 137 August 138 September 217 October 349 November 426 December 417 1993 January 484 Fubruary 569 March 662 April 767 May 919 June 1082 July 1025 August 1233 September 1350 Mooiy Aveage Source: National Bank of Tajikistan.  EXECUTIVE SUMMARY Tajikistan's economic situation has been affected by unprecedented shocks since it gained independence. Since 1992 the country has undergone a protracted period of civil war, political instability, and major natural catastrophes. The resulting economic difficulties have been compounded by additional shocks stenuning from the collapse of the trade and payment system, sharply higher prices for transport and energy imports, and the discontinuation of the transfers from the fomier Soviet Union (FSU). Between 1992 and 1993, civil strife and political turmoil killed about 50,000 Tajiks and displaced 850,000 more, of whom 150,000 sought refuge in neighboring countries. Many villages were substantially destroyed. Looting was extensive and total damage to homes, infrastructure and other sectors in the country reached devastating proportions. In addition, in 1992 and 1993, the Yakhsu and Kyzylsu Rivers, north of Kulyab, severely flooded and caused extensive damage to flood protection dikes, roads, bridges, villages and cultivated land. Because of the political turmoil and fragile secrity situation, Tajikistan has received very little development aid other than UN humanitarian assistance. Even before these shocks Tajikistan was the poorest country in the FSU, and therefore faces some of the development issues common to most lower income countries. Per capita income was already below US$500 in 1992. Tajikistan is also a rral country. While agriculture only contributes about 40 percent of Net Material Product (NMP), 70 percent of the population lives in nual areas. Only 7 percent of the land is amable, and is heavily irrigated. Tajilkstas main products are cotton, silk, and livestock, especially sheep. Industry, which contributes 30 percent of NWP, consists mainly of labor- intensive processing of indigenous and imported materials. Hydroelectric power supplies 75 percent of the county's electric requirements. Although Tajikistan has many natural resources, including gold, mercury, and other minerals; its foreign trade focuses on a limited range of products. Aluminum, raw cotton. and textile products make up about 60 pecn of exports. The remainder is concentred mainly in fruits and vegetables, silk, marble, hides and electricity. The couty imports a large part of its energy needs, parficularly petroleum products, almost all manufacred consumer goods, and, increasingly during the last two years, grain. The economic difficulties posed by the combinton of shocks and impoverished initial conditions were aggravated because initial progress on structural refoncs was not ssained, and even reversed. Total output has declined so much that in 1993 real NM was only about 40 percent of the 1988 level. The drop in output has been accompanied by a very large fiscal deficit, resulting from the Govermnent's attmpts to mantan living standards by increasing wages and subsidies. The budget deficit was around 30 percent in 1992 and 24 percent of GDP in 1993. Such a high deficit was somewhat masked by the fact that Tajikistan was part of the mble zone and, thereby, continued to be financed by the Russian Central Bank. During 1993, the consumer price index increased tweny-fold in line with Russian inflation. In addition, given Tajflistan's unp ed output declines, it is urgent to adopt htrucural and stabilization measures that will bring about an eventual supply response and recovery. This reform must be coprehenive; a piecaemal approach will neither move the economy out of its current crisis nor help obtain much needed assistance from the iternational financial communty.  xii Executive Summary Economic Reform Program The Government's first priority should be to stabilize Tajikistan's fragile political and security simation. As soon as conditions allow, reconstruction should begin in parallel with efforts to stabitize the economy. The most essential infrastructure which was damaged by civil strife and recent floods will need to be reconstructed first. A recent review undertaken by the World Bank to identify the main elements of an Emergency Reconstruction Program identified urgent needs, partiularly in agriculture and flood protection, transport, teleconmmnications, housing, and the power subsector. In addition to reconstruction and stabilization, the Govern-ent needs to inplemnt structural and sectoral reforms to promote a smooth transition to a market economy. Some of these reforms could start to beu fruit even before there is an improvement in the security situation. Others would stand a better chance of success once there is political stability, and should therefore be postponed for the time being. Stabilizatio Policy Faced with a tense security situation and economic difficulties, the authorities continue to rely heavily on close political, military, and economic ties with fte Russian Federation am have been negotiating for Tajildstans entrance into a monetary nion with Russia for almost a year. In September 1993, the two countries signed an agreement on the general principles to create a monetary union but the framework and operational arrangements are yet to be finalized. The authorities' efforts to form a monetary union are understandable since present conditions are not the most propitious for launching an independent currency. If the Goverunent decides to enter a monetary union, negotiations with Russia should be quickly completed. If the decision is made not to enter into such a union, the appropriate conditions for the successfil intoducion of a new currency should be created as soon as possible. The resolution of monetary arrangem.ents, whether entering a monetary union with Russia or issuing a national currency, will determine the nature of the country's stabilization program. If Tajikistan decides not to enter the monetary union, it would be able to follow independent monetary and fiscal policies conducive to achieving macroeconomic stability. However, having an independent currency would have some drawbacks. It would probably bring about a reduction in the level of financing and transfers from Russia and greater short-term obricles to trade. Moreover, the existence of low and distorted interest rates, restrictive excbange and trade regulations, and insufficient institutional capacity, including at the National Bark of Tajikistan (NBT), suggest that the Govermnmen is not yet ready to manage a national currency. Although under a monetary union macroeconomic stability would be contingent upon the policies of the Russian Federation, Tajilistan would have to address some of its institutional shortcomings as it would be required to harmonize the country's monetary and exchange policies with those of Russia. Regardless of which choice is made over currency arngemets the authorities need to stop their expansionary fiscal policy. Introducing a new currency would require the budget deficit to be reduced to diminish inflationary pressures and establish confidence in the new currency. A monetary union with Russia would also inpose constraints on money and credit expansion and require the budget deficit to be brought under control because of monetary union provisions and limits on the amount of financing to be provided by the Russian Federation. The need to reduce the budget deficit (expected to be around 20 to 25 percent of GDP in 1994) leaves authorities no choice but to contain subsidies to enterprises and consumers and to accelerate efficient revenue generating measures. Measures already introduced in the 1994 budget include  Executive Summary xiii conining local expenditures within available resources and requiring the Pension and other funds to submit anmual financial statements on their operations. There are several important measures that the Government should take in the next year to reduce social expenditures, while at the same time rationalizing social services. Some revenue genaing measures have already been introduced, such as increasing the income tax and elimit exemptions to the eterprise profits tax. TMese measures should be supplemented by applying a uniform enterprise profit tax rate to different sectors. This would discourage investment of resources in relatively less productive sectors to exploit tax advantages. In addition, the Value Added Tax (VAT) should be fully paid by state fanms and cooperatives. Excise taxes that result in little revenue, together with all taxes on aluniinmm exports, should be abolished. Stuctural Reforms In the Short Term In the short term, the most urgent strutural reforms are price liberalization, the acceleration of privatization of small-scale enterprises, and removing obstacles to private sector growth (most critically for small businesses). These reforms could start to bear fruit even before there is an improvement in the security situation. The design and implementation of the institutional and legal enviroment needed to support a market economy is an area were progress should also be made in preparation for the post war period. Price Libalion. Tajikistan iinated price liberization in April 1991, fbllowed by a wider mund of price increases in January 1992. when price controls on 80 percet of goods were eliiated. Although the Government has further liberaized prces since then, a significant portion of consumer goods still remain under price controls. These include varous grades of flour, bread, milk, energy products, utilities, rent, transport and commications services. The budgetary cost of subsidies for all these commodities amounted to about 7 percent of GDP in 1993, burdening an already difficult fscal situation. Moreover, subsidies create a distorted incentive struu through which producers of agricultural goods and providers of basic services are penalized. Subsidies, therefore, result in a disincentive to produce the very goods that the Government so highly values. Stronger measures are required to reduce or discontinue all commodity subsidies, especially on bread, meat, and milk, allowing their prices to rise to market-determined levels. The adverse impact of diminating price subsidies on the poor should be addressed by means-tested budgetary transfers and targeted social asisn. Privatiation of Sma-Scale Enterprises. The Tajik Government has developed a privazation progran for small enterprises. Implemenion has been slow and the progran should be accelerated during 1994-95. The privatiztion program requires adininistatively simple procedures since it will involve privatizing over 5,000 small-scale enterprses. The Govermment needs to develop stndardized guidelines for enterprise seecton and valuation and to accelerate the work of individual privatizaton committees. In 1994-95, the State Propety Committee (SIC) should laumch a series of fair. open, and regularly scheduled small-scale auctions. beginning m Dushanbe. Auctions of small-scale enterprises are a proven way to encourage privadzation. The pmcedures for holding such auctions are not complex, and the implementation rements are simple, once consensus is achieved on the need for privatization. For small-scale enterprises, the transition from collective forms of ownership should occur as soon as possible.  xiv Executive Summary Primate Seaor Deelopment. A stromg private sector must be developed to support Tajikistan's transition to a market-oriented economy. The Govermnent has taken certain measures in that direction, creating the National Association of the Medium and Small Business and establishing a fund to support private business. However, these types of organizations should be created by the private sector. Government-established business organizations do not have a good track record in prmoting private sector development. The Goverment, however, has a very important role to play in the transition in removing t constraints that ihibit the growth of the private sector. Private initiative in Tajikistan is now constrained by political and economic instability, legal and regulatory inconsistencies, and constraints on foreig trade. As a first step the Govenment should adopt a simple and automatic license and registation process for new businesses, with inimal requiemnts and uncomplicated forms. The Goverment should also allow business associations and information centers to disseminate inormation and provide business services. Completing the legal framework necessary to move to a market economy should also be a priority to promote private sector development, including the specific measuems descrbed below. In addition to a clear Legal framework, the private sector needs confidence in the enforceability of agreements, transparency in dispute resolution, and recourse against arbitrary administrative acts. hutaional and Lega Environent. Tajikistan has enacted several laws aimed at developing a market economy that address specific areas and actvites but do not yet provide an overall framework for developing a market economy. There are signficant gaps in such areas such as property rights, conact law, securd tansactions, transfer of property, and protection against unfair trade practices. In 1994-95, emphasis should be on adoptirg a modem constitution that gouantees the right of natual and jundical perso to own and exchange property protecs prvate property, and provides for an indendentjudiciay. Modem civil and commecl codes thatprovide awell-defined framework for entry and exit and for market activities, need to be deveioped. Other importa aspects of a necessary enabling legal environmen include implementin mechanisms to register proper rights, and revision of th 1991 law of stm ownership and privatzion of property and related implementtion decrees. Institutions critical for the success of legal reform, such as company registration offices and banking regulation offices, should also be established. This requir an overall review of administrative refform masures and traing officials in legal and regulatory aspects of economic reform. It will also involve srting the judicial system's ability to enforce the ecomic laws and contractual obligations essentil to protect property rights. In the Mediun Term Over the medium term, the structural reforns which are discussed below are necessary to continue building the foundation for a market-oriented economy. They include the implemention of a modium- and large-scale privatization progrm, enterprise restructuring, financial sector reform, reforms of foreign tade and the foreign investment framework, and a social safety net. These reforms would probably stand a betr chance of success once there is political stabiity after the ongoing conlict is resolved. Medium- and Large-Scale Pvadon. The design and inplementation of a medium- and large-scale privatization program is cnucial for the reallocation of resources to their most productive use and, therefore, for long-term growth. Without a change of ownership from smte to private hands, the enterprises may not gain access to investment, technology, and market-oriented management needed to survive. Also, until they are privatized, many state enterprises arc operating in a planning vacuum. The currentprivaizaion strategy has severl flaws, including a cumbersome and non-competitive decision  Executive Summary xv maldng process, which will not allow privatization to accelerate. The privatization program needs to be redesigned and the numerous legal and political obstacles removed. The revised program should encourage broader participation by private individuals. The inidtial cautious and restrictive policies -mst be revised to encompass a broad range of methods and sales strategies. Once this is completed the Governmen should: (i) implement a mass privatization program and prepare a list of medium and large enterprises to be privatized; (ii) establish voucher-based schemes (paper vouchers, points, or savings accounts) while simultaneously introducing case-by-case larger scale privatization; (iti) simplify procedures for enterprise valuation and develop smndardized documents and guidelines to accelerate the work of individual privatization committees; (iv) design information packages for enterprises explaining what needs to be done, and by when; and (v) set up simple systems to evaluate and approve privatizazion plans. Enterprse Resmruuring. Enterprise restrucaring is likely to be one of the most challenging components of the reform program because it will probably entail output decline and unemployment. The experience of other countries suggests that it will take several years to complete the privatizaion process. In the interim, those enterprises remaining in the public sector should operate in line with private sector practice. Commercialization should be encouraged by establishing commercial goals and imposing hard budget construaints. Organizational changes that delegate authority to appropriate levels of management, create mechanisms for owner representatives to monitor performance, reward success and punish failure should also be promoted. The major loss-making enterprises should be liquidated and prevented from having access to the finani sector, so they do not comromise stabilization or financial reform. The Govermnent has started this process but management has very lite autonomy. New measures should remove the state frm direct involvement in day-to-day decision making of the enterprise. Credit to enterpnses should be conditional on clearly defined restucturing or liquidation plans for nonviable enterprises. These steps are all necessary, since htying to maintain employment in stte-owned enterprises will put more pressure on the already staned budget, making stabilization of the economy more difficult. Fainwcial Sector. Financial reforms should focus on eiminating the centmal dieton of credit to specific sectors and allowing commercial banks to play their in di role. The Government should encourage development of a financial system capable of mobiiig financial savings and channeling them to the most efficient sectors of the economy This will require allowing noninal interest rates to increase, at least to Russian levels in the event that TaJikistan does finalize monctay union arrangemnents. Emerging commercial banks should be fieed from the influence of non-viable clients and be allowed to focus on supporig the emerging private sector. In the medium term, bank lendng Fhould be based on commercial criteria and proper evaluation of client creditworthiness. Effecive prudental regulon modern accounting and auditing stndards, allowing entry to foreign bans, ind enforcement of existing regulations on concentrated lendig and loans to reLated parties, are needed if commerdal banks are to fulfill their necessary role in the transition to a market economy. While all te measures would only have an impact in the mein term, it is important to start preparng them since they take a long time before theW are ready for ilemeon. Trade Regime. Tajikistan has inherited an economy that is highly dependent on trade and vulnerable to exernal shocks. Approximately 80 to 90 percent of Tajikistan's exports and imports are with the FSU. The country's production strun also requires considerable imports of capital goods. well in excess of export earnings. Exports make up about 40 prcent of NMP; imports. 50 percn. Tajikistan's trade regime is charactrized by substnial Govenment intervention and effrts to sustain  xvi Executive Summary the old production structure. The focus of the trade regime should shift to the future. The activities where Tajikistan entrepreneurs have comparative advantage n inteanational markets will only emerge after the trade regime is simplified and protection made low and homogenous. Trade policy should not be designed to protect ailing industries. Imports will have an important role in the post war recovery. They will also provide competitive pressure on domestic enterprises, especially on existing monopolies. Trade liberalization can, thus, be a major force behind productivity growth in Tajildstan. But to finance imports. exports need to provide the necessary foreign exchange earnings. And existing policies wiUl not geneate the desired carnings as they penalize exports. Therefore, export licensing and export quotas should be discontinued. Trade poliry should be simple and tasparent. Tariffs should be uniform and ad valorem. If Tajildstan joins the monetary union with Russia, its import tariffs should be consistent with Russian tariff coverage and rates. Foreign Direct Invement. Tajikistan's experience with foreign imvestnent is very linited. As of October 1993, only 12 enterprises were whoUy owned by foreigners and 47 were registered as joint ventures with foreign participation. Atacting fbreign direct invesutent would help Tajikistan to obtain access to modem technology and intemational marketing know-how. Enbancing inernaional confidence in the economy is the most important prerequisite for attracting foreign interest. To build up such confidence requie politcal and economic stabity as well as credibility in the Governments commitnent to the appropriate policies. It also requires an enabling legal emviromment The Government guarantees that the provisions of the current Law on Foreign lnvestnen adopted in 1992, will be applied for 10 years and that foreign prperty will not be nationalized or requisitioned. Forign investors are granted the right to tansfer their investments and pmfits out of the country. However, a detailed set of rules pemitting .foreign investors to tansfer dteir bard currency in and out of the country has not yet been fmalized. The law on foreign investment also needs to be reviewed to remove excess registration requirments and simplify concessions. The essential prerequisites for negotiating investment agreements are curently weak because information, such as conditions of local enterprises, sectoral analysis, and fincial statmets with intrational standards (usually demanded by intrational investors) is incomplete or unavailable. The institutional seting for foreign irvestment is complex, involving at least two ministries. The Government intends to create an independent Agency for Foreign Ilvestments that will have a central role in coordinating foreign investment acivities and will become a center for information, policy, and investment promotion. This is an important step. The Govemment will also need to develop an easy entry and exit process and improve the country's infrastructure in telecommunications and transportation. Opening up the privatization process to foreign investors by removing dght requirements and ceilings on participation will also stimulate and attract further foreign capital. Over time, attention should turn to atcing interational investors to explore the country's promising but as yet unexploited geological fornations. Social Safety Net. The transition to a market economy will impose unavoidable hardships on the population. Reducing subsidies will diminish living standards. Real wages, which have already declined, will further decrease. And unemployment could rise considerably. Inefficient enterprises will probably fold faster than efficient private ones can emerge - this is a comnon feature of the transition toward a market economy. If popular support for reform is to be maintained, the Governmem wii need to revise its social policies to address these transitonal problems. inescapably, the generosity of the old social system cannot continue and mst be replaced by more realistic responses. Resources are scarce and notwithstanding the impornce of immediate revenue-generating measures, the possibiliry of considerable tax increases are limited in the short run. On the other hand, the scope for financing budget deficits through currency emission is limited if stabilization is to succeed. Under these conditions, while  F-xecutive Summary xvi essential social safety net spending should be protected, social expenditures should be restructured and econonized through targeting to the most needy and reducing the level of some benefits. During 1994-95, steps should be taken to rationalize social expendiures by improving targeting and sharpening the eligibility to the various welfare program. Temporrily disabled workers and working pensioners should not be eligible for pensions. The minimum pension age, currently 60 for men and 55 for women, should increase over time. Unemployment benefits should be paid only to persons employed regularly during the previous year. And paid sick leave should be cut to one month per year and paid maternity leave to six months instead of a full year. For the remaining eligible population, several changes in payment scales should be made. A sliding payment scale, reflecting the decli-'- in margia cost per extra child, should be implemented. At the same time, the Government should also balance its policy of providing child allowances to large fimilies against its objective of population control. Per capita monthly paymen of 1800 rubles to compate for rising bread prices should be scaled back and targeted to the very poor. Sectoral Transformation Structural reform must first be implemented in the specific sectors, such as agricalture, that can generate the faest growth response. The infrastuCture that was damged during the civil stife and recent floods must also be reconsed as soon as the seuity sitation impres to facilitate a supply response in the productive sectors. The agriadtural seaor, which domintes the Tajik economy, needs immediate refonm to promote the economy's rcovery. Although per hectare yields of cotton, the major cash crop, had been the highest in Cental Asia, because of lack of inputs and poor weather, production in 1993 was 38 percent below 1991 levels. The main policy actions required in the short term inude the eiminon of the state order system, Liberalization of prices, and the establishment of prvae land ownship. There has been ittle change so far and the state stil dominates prices, input distribton, and production of key crops. In 1993, the Goverment tightened controls, icreasing cotton delivery quotas from 70 percent to 90 percent of production. Free output prices, coupled with the demonopolizadon of agricuural tade, would give an immediate incentive for collective and state farms to incease efficiency. State farms should also be made accountable by andonnming them to private individual farms or cooperative farms with fll legal and tradeable property rights. Price liberzation should bring about an immedit supply response as soon as profitabMity improves and armers take beter care of their crops and lnd. Over the medim tem, agricultural output should increase even more as farmers faced with higher pnces for their products look for better crop varieties and improve their on-fam water managemet and production techniques. For example, former levels of cotton production could be obtaned with 20 percent less crop area if yields would increase to those of other counties with similar cmate conditions. There is also considerable room to improve livestok production. While almost half of the sectr - other than poultry - is privately owned, the remaining state livestock sector should be privatized. The agricultal sector's problems cannot be resolved under the structure of a command economy. Not only do prices of inputs and outu have to be left free of state intrvention, but the private sector has to be allowed to trade, transport, and disbute. Mega trucding enteprises should be broken up and the ransportion units of various ministries, of the concern Madad, and of state farms should be privatzed. In a market economy, the state does not have a role in direct distribution, processing, or in wholesale and ret trade. When farmers are allowed to get the market price for all  xviii Executive Sumnary their products, the rationale to subsidize inputs and credit will disappear. This sector's pmductive profile is likely to look very different under a market economy than it does now. The inevitable restrucuring that will take place will challenge deeply rooted political beliefs concerning the role of the state and its ownership of land. Some products will not be profitable in a market economy and some existing kolhotz and solhotz will inevitably incur losses. The temptation for the Govermment to step in and hinder the development of the market should be avoided. Otherwise, the benefits of the reforms will not be allowed to surfac. Industri Sector. The collapse of the interrepublic payment system, the disappearance of markets, supply shortages, terms of trade shocks, and a general drop in investment during the 1980s have put considerable pressure on the industria sector. In real terms, industial output decl,ed by over 50 percent between 1990 and 1993. Controls, through decrees and resolutions which seek to centrally manage procurement and distribution and implement intergovernmcntal agreements by state orders (now covering 70 percent of output), have been tightened. This desperate effort to secure minimum supply levels has not been effective. Moreover, Govemment intervention in the industrial sector has hampered restructuring and has postponed necessary adjustment to the new ranlities imposed by the loss of Tajikistas main tradig parmers and other permanent shocks. In 1994 and 1995, reforms should begin by elmnating state orders and by lmiting price regulations to specal cases of natural monopoly. All enterprises, whehreprivate or state, should have equal access to credit, have the same tx reannent, and be subject to the same provisions of the comnercial code and bankruptcy la-ws. Subsidies, if any, should be explicit budgetary transfers, so that their fiscal cost is clear. Budgetary tansfers, in trn, should be compatible with the desired budget deficit reduction. Because of its implications for the overall industrial sector, it is urgent for the Government to decide, by the end of 1994, on the particula option it will choose regarding the alumnrwum smelter, which currently wastes a large amount of resources. At present, about 40 perct of hydro- power goes to the alumi=n smneter. If a strategic investment partner cannot be found to provide the necessary technology and capital to carry out the required restuctring, it is recommended that the Government consider shutiing down the smelter, thus saving on electricity use. The social costs of closing down the unit, in terms of unemployment and family hardship, can be addressed though the social safety net. Another urgent industia subsector that needs atention is the food industry. where quality ard safety standards are in urgent need of improvement. The mining sector in Tajikistan has substantial potential, in gold, silver, mercury, zinc, and other metals. Despite the richness and diversity of deposits, some of the existing mines are depleted, remaining deposits are underdeveloped, and national production is far below previous levels. In order to realize its potential, the mining sector must mobilize substantial amounts of capital. Investment will be required not only to reconstuct and rehabilitate war-danaged operations, but also to develop some of the potentially valuable deposits. Tajikistan faces significant competition from other resourc-rich countries for what is likely to be a limited global pool of mining funds. To auact even a small share of these foreign funds the Govermnent must have a sound policy framework for mineral development including a revised mining law that is not open to ministerial discretion and which has transparent samtutes and a clear tax and royalty regime. The authorities should also document internationally acceptable evidence of the attractiveness of deposits in terms of size, grade, and other technical specifications. Tajikistan's educational system provides free education for virtually every citizen. Educational ataintent is high relative to the countrys GDP per capita and there is universal access to nine years of education. Nevertheless, the quality of education is rapidly deteriorating. There have been declines in enrollmet, inmuctional hours, and teacher-to-student-contact. The declines can be linked  Executive Summary xix to expenditure reductions in inputs such as textbooks and teacher skill upgrading and the growing share of expenditures going to saaries and benefits to compensate their erosion by high inflation. In the short term, non-salary recurrent expenditures should be protected from furtfer cuts. Over the nedium term, efficiency gainsare one of the few tools the Government has at its disposal to halt the decline in the quality of services. Considerable efficiency ga-s could be realized by expanding the mber of teachng hours, increasing class size, and reducing the oversupply of teachers (which might have already happened due to the sharp decline in real wages in education). Health sertices in Tajikistan are free. The Government inherited from the soviet system a widespread regional network of health faclities that deliver a quality of care above Tajistan's inc level. The population's health profile is a mixture of developed and developing countries. In the past, immnmization coverage was excellent and childhood diseases were under control. Currently, infant and child mortality and morbidity are caused mosty by infectious diseases, while chronic disease is responsile for most adult mortality. High incidence of diarrheal diseases, hepatitis A, and other gastrointesnal diseases indicates poor water and sanitation, as up to one-third of the popuon has no access to rnng water In the short term, the Government needs to address problems in the health sector that stem from the civil war and natural disasters. Rect outbreaks of measles, polio, diphtheria, and cholera should be viewed as early signs of a breakdown in healdt care delivery. The shortage of supplies is contbuting to the health care emergerny now developing in Tajikistan. It will be necessary to provide vaccines and essential pbarmacriial supplics to most of the population for at least a year. Provision of equipment and spare parts to rplace some of the mateials lost in the war and flood, as weU as some important equipment rendered useless due to lalck of maintenance, is also necesary. In addition, there are structural problems facing the sector, some of which need to be quicldy addressed. Private sector paricipation needs to be encouraged by establis'ing clear procdures for licensing private practitioners and nursing homes. This could immediately relieve pressure on the health care system. In the medium trm, improvemeanls in efficiency, planning, and management in the health scetor are vital. Population-to-doctor raios in Tajikista are generous by middle-income developing country standards, though below other FSU oDuntries. The Ministry of Health needs to ientify those specities most in need of new personnel and those that are overstaffeI, so it can stop training health professionals that are in oversupply. Attention should also be paid to promoting preventive care, health education. and imprvement of mntrition and fraily planning. Training health care professionals in modem medical technologies and pmceAres and strengthening the Ministry of Healts institutional capacity are other important areas for the medium term. The Energy Sector. Although Tajistan's per capita overall ener consumption has fortunately been historically among the lowest of the PSU, the fuel shortages which have resulted fm the war are among the worst ever experienced in the region. Most of domestic energy production is concentrated on hydro-dectricity and the country relies on imports for nearly all of its oil and gas needs. In the short tern, the Government must develop a strategy to deal with the fuel shortges, ensuring that key agricultur and essential industry activities and services are not fiurthr disrpted. It is important that the acdvities of Nafesmn (which is responsible for oil product distbution) be made more transparent to allow fidl oversight of its economic activity. To ensure that energy use is as efficient as possible, a rapid transition to economic pricing of energy should be implemented. Prices for electricity and fuel to households wDI have to be raised. While it may not be practical to ask households to pay the full economic cost of fuels immediately, prices shoud be raised substantially and comensaton tough the social safety net mechanism shouid be considered for some spedfic groups.  xx Executive Summary In the medium term, the energy sector's institutional capacity must be strengthened in order to better develop and implement energy policy. The responsibility for energy policy and oversight of energy enterprises should be centralized within a single ministry or department. Once the fuel supply situation has been stabilized, the policy focus should shift to strategic investment planning and restructuring. An assessment of fuel use priorities will be important. A key consideration will be the best use of Tajikistan's large, installed hydro-power base. As part of a review of both the energy situation and the alumninmn smelter's future, it will be important to tale full account of the economic cost of this enterprise's large use of fuel. Reduced demand fron the smelter could allow greater use of electricity in domestic heating and cooking, for example, which would save high cost imports of LPG and natural gas. It also is possible that power saved by reducing the alumiinm smelter's use could be exported to neighboring countries to help fnance the costs of oil and gas imports. The future development of Tajildstan's large hydro potendal is another key imsue. In view of the high costs involved in constructing the Rogun and Sangtudin projects, and given the uncertainty of demand from both domestic and export markets, it is recommended that further work on these projects await the outcome of a special study to analyse the export demand for power from the Rogun project (from such countries as Pakistan and other Central Asian countries). Environmental and social impact of the construction of these projects should also be careful!y evaluated before further work. Transport and Telecommunicadons. Although Tajildstan's transport system is relatively well developed, lack of competition has kept it from reaching a state compatible with the requirements of a market economy. Eliminating excessive regulations and creating necessary incetives to restructure the transport enterprises are critical for the system's efficient development. In the medium term, the privatization plan should cover enterprises in the transport sector. Enhancing the efficiency and productivity of the remaining state-owned trsport enterprises should also be emphasized. Like its trasport systems, Tajikistan's telecommunications system also needs inprovement. Immediate emergency reconstructon is needed in Dushanbe and the southern part of the country to restore capacity to levels prevailing before the civil war and floods. Active private sector participation could play an important role in developing this sector. Enmironnment. Water resources, fertile soils, and biodiversity (flora and fauna) are primary national assets of Tajikistan. These assets, as well as clean air, are being threatened by failure to take environmental considerations into account in agricultural practices, industrial development, and waste management. For instance, the inappropriate use of pesticides and fertilizer in the major cotton producing areas has contaminated the soil as well as surface and ground water. Given the wealth of its resources and the considerable vulnerability imposed on them by topographic and climatic conditions, it is important for Tajildstan to develop mediun-term strategies to promote better drinkdng water distribution, treat waste water, manage solid/hazardous waste, replace polluting technologies with cost- effective dean technologies, construct adequate drainage systems that minimize soil salinization, install efficient irrigation systems and implement environmentally benign pest-control options. The authorities should adopt realistic standards for air and water qualiry and establish interim emission standards that will allow a move to the new standards within a reasonable time period. Medium-Term Outlook and External Financing Requirements As the political and security conditions stabilize and the Govermnent demonstrates its comnmitment to the stabilization and structural reforms outlined in this document, the economic decline could be moderated. Overall output could stabilize within a few years after reforms have started and have shown positive growth rates thereafter. Over the medium term, the agricultural sector can be expected  Excutive Summary xxi to grow steadily as reforms are implemented in the areas of producer prices, state orders, distribution and ownership of agricultural assets. Assumning that trade agreements with the FSU, particularly Russia, are reached and that the Government proceeds with privatization and enterprise reform, the industry, service and trade sectors will likely stabilize after a few years and will start growing thereafter. Provided that the Government remains committed to reforms, a limited recovery of investment may be expected to materialize primariy in infrastructure repairs, housing, and construction. Since the population will try to maintain previous consumption levels, it is expected that private savings will not start to rise before the third or the fourth year after reforms begin. With progress in privatization, price reforms, better targeting of social assistance, and tax reform, p"blic savings could improve. It should be noted, however, that even with strong stabilization and structural reforms and adequate donor support after four years. real GDP will most likely reach only 50 percent of its 1990 level. The country's development prospects will not be realized if the Government is unable to introduce a comprehensive economic reform program. Without reforms, the process of reallocating factors of production would not start for sometime and adjustment in the industial sector would be delayed, severely limitng supply response possibilities. With continued state orders in agriculture, tight control of production, and inadequate supplics of imported inputs such as ferlizer, agricultural output would continue to decline. Wlthout die necessary legal and regulatory framework it is expected that the formal serice sector would not resume growth. Delayed trade reforms would cause Tajikistan's exports to stagnate while its import requiements would continue to be high. Lack of inputs, condtnd centrlzed procurment, and export restictions would limit cotton exports. Sinee Tajiastan's imports are made up mostly of petroleum. natural gas, and grain, - products with low easticities of substitution - the decline in import requirements would be limited despite fallig growth rates. Under these conditions, Tajikistan's extrnal financing requiements would keep on growng. In the absenmc of a stabilization and stn dual reform program such a gap could not be financed. If the refom measures are implemented, the interatiDnal community is likely to contnrbute to the financial and techical assitance needs of the country. Technical assistan=c will be needed to overcome exisg bottlenecks and istitutional constrawits. External financial resources will be required to finance pnority imports needed to rehabilitate the economy and fcilitae the recovery of production. Due to isufficient information, it is extremely difficult to project the cor's trade prospects and financing requirement. But prelinary estmat suggest that Tajikistan's financing reqirements could average US$260 to US$280 million per annm over the fist few years of reform. Although these are large amounts they could be mobilized from international donors provided Tajikistan undertakes meanigful economic reforn and atains political stability. Tajikdstan's financing requiements are large in reion to its economy and debt servicing capacity. To decrease debt servicing costs - to a manageable level of around 20 percent of export earigs - most of the country's financing and technical assistance would need to be in the fonn of grants or highly concessional loans. The combination of a strong reform program, the country's low per capita income, very large consumption decline in the past few years. and almost negligible creditwortess justify a large degree of concessionality in its financing requirments. The World Bank has identified Tajistian as an IDA-eligible country. There are risks to the reform program: (i) continued political instability; (ii) weak commitment to reform; (iii) limited implememttion capacity; (iv) adverse external enviromnent; and (v) unavailability of exernal finang. The frile political situation poses the most uncertinty,  xxii Exeutive Summary diminishing public confidence in the economy and hindering the successful implementation of reforms. Even if political stability is achieved, lementng the reform program may result in a drop in real wages. generating dissatisfaction among wage earners. Reductions in conswner subsidies and the need to exercise financial discipline by enterprises may also increase opposition from managers who have benefited from soft loans and easy budgeing. Pressure from dissatisfied grups may delay or even derail the reform program. However, without reform, economic instability will increase and the economic crisis will deepen. The costs of exorbitant inflation, inefficient enterprises, and unfulfilled financial and technical assistance requirements would then far exceed the costs of continuing reform. With political stabiity and genuine Government commitmen to reform, the authorities wiU still be confronted with the complex task of designing and implementing the reform program. Tajikdstan curently lacks the institutional capacities and the skill and experience required to design and carry out the refonn program and move toward the market economy. Tecnical assisuce from the World Bank and other donors should be provided to facilitate the design of a refonn program and enhance the Govermnent's implementation capacity. The extrnal and exogenous environment may also undermine the success of the reform program. ln addition to the increase in security-related expenditures in te absnce of peace, odter exogenous fctors influencing the reform programn include economic and political developmentsin dh Russian Fedration, with which Tajikistan mamitins close ties. FmnaUy, lack of adequate extenal financing could jeopardize the success of the reform progranL Extenmal financing is dependent upon both the resolution of the conflict and the implementation of reforms. W-ithout extenal financing Tajildstan must cunrml investent and consumpdon - to the detrnent of output recovery and public support for oontnuing the reform progrm. Design and implementation of a comprehenive reform program wil be critical to mobiizing the necessary external resources for on and to meet the countrs technical assistance requiremets. Tajikistan has no dieu experience with manag eterna fianca and technical assistance. Effecrve use of these resources very much depends on the countr's ability to coordinate the varous types of assince, inludig matching requirements with available resources and making effective use of available aid funds through knowledge of the ive, financial, and procurement procedures of various aid agencies and donors. The World Bank has provided a grant under the Insdtutional Developmet Fund to assist Tajildstan in setting up an External Assistance Management Unit.  THE MACROECONOMIC FRAMEWORK This part of the report reviews recent economic development in Tajikistan (Chapter 1). It then analyzes the priority measures necessary for the transformation and stabilization of the economy, assesses the medium-term outlook of the economy and evaluates the country's external financing requirenit (Chapter 2). The disruption in the trade and payments systems has complicated macroeconomic management and the civil strife and floods have heavily damaged the country's infrastructure. Output bas significatly declined, prices have sbarply increased, public finances have deteriorated considerably and real incomes have been substantially eroded. Resolving the current economic difficulties requires the Government's firm comitment to initiate a reasonable refonu program. The economnic crisis has deepened to an extent that no further delay of reform measures can be countenanced. Provided the Government shows strong commitment to stabilization and strucural reform as discussed in Chapter 2, the decline in economic activities can be moderated, overall output is likely to stabilize by 1995, and positive growth rates will be realized thereafter. Adoption of such a reform program will encourage financial and technical assistance support from the donor community.  CHAPrER 1 BACKGROUND AND RECENT ECONOMIC DEVELOPMENTS 1.1 Tajikisman is bordered by Uzbekistan, Kyrgyz Republic, China and Afghanistan. Its territory is largely mountainous and includes the FSU's tallest peaks. With an area of 143,000 sq kan and a population of 5.6 million in 1992, Tajikistan has the highest rate of population growth - 2.9 percent - in the FSU. Eighty percent of the population is Muslim. The ehinic distribution is 62 percent Tajik, 23 percent Uzbek, 8 percent Russian, 1.4 percent Tatar and 1.3 percent Kyrgyz. The modem Uzbeks, Xazakhs, Kyrgyz and Turknens are of Turkic origin; the Tajiks are Persian in origin. 1.2 The political situation remains tense and fragile. After independence in September 1991, clan and regional rivalries, dormant during the Soviet era, erupted into civil war. The war ended in May 1992 %t'en a coalition Government was formed, but was short-lived, as the parliament voted the President out of power in September 1992. A broader based coalition ruled for one month, after which Parliament elected Imamali Rahmanov Head of State. The Rahmanov Government has been able to gain control of most of Tajikistan's territory with skirmishes confined to a strip around the Tajik-Afghan border. Outside military support has come mostly from Russia and Uzbekistan, although some troops from other neighboring republics have also been involved, e.g. Kazakhstan and Kyrgyz Republic. 1.3 Since 1929, when it became a Soviet republic, Tajildstan has had a centrally planned economy with extrmely close ties with the other FSU republics. Before its independence in 1991, the country gradually shifted from a strictly rural and nomadic economy to one with a substantial industnal sector, which primarily produced semni-processed raw materials. idustrialization was made possible by large investments financed by Union grants and subsidized loans. A basic transportation network of roads, railroads and aviation was developed. Substantial investment in the social sector has resulted in near universal adult literacy and a free and relatively well developed health care systemn However, with per capita income of US$480 in 1992 - about 55 percent of the Soviet average - Tajilcistan remains the poorest FSU republic. 1.4 - Despite its independence from the F Mal a m hdcatm FSU, Tajikstans economy remains highly FM"* of 9Sa _d. Unin dependent upon that of the Russian Federation and tanr%m hIn S- si*dudod. other FSU menbers. The structure of production, - particularly the industrial sector, is still highly integrated with the FSU, due to regional specmalizaion imposed by central planning. This 1 1 fli exposes Tajikistan to the FSU's economic -'a U J instabilities caused by disruptions in trade and -s payments systems and complicates -| macroeeonomiv management. At the same tme, civil war and floods have heavily damaged -o -n an _ Tajistan's infrstructure imposing additional _ W constraints on the country's development. As a result, Tajikistan has experienced much more severe output declines tm other FSU countries, as well as unprecedented price increases, an erosion of real income and loss of control over public finances. (Sce Figure 1.1.)  4 Chapter 1 1.5 Poor data make it difficult to assess the overall mac oom ic situation. The civil war led to breaks in key production figures. Data on consumption, savings, and investment after 1991 are not fully consistent or organized in a national accounting framework. Price indices arc not comparable over tine. Items that could not have been produced, due to shortages of raw materials and the civil war were dropped from the indices, making inflation calculations difficult. Trade data are not reliable, and there are significant gaps between domestic production and export and import figures, particularly with respect to cotton (possibly reflecting unrecorded transactions). Due to the civil war and the country's instability, the newly created NBT lost a large number of its skilled staff, which led to breaks and inconsistencies in monetary data. Production and Expenditure 1.6 After growing at an annual avcrage rate of 2.5 percnt between 1980-85 and 4.7 percent between 1986-88, Tajikistan's economy began to contract in 1989. NW fell by 2.9 percent that year. Since then, output has been declining. While the drop in output was limited to 1.6 percent in 1990, it accelerated significantly during 1991 and 1992, when NMP declined by 12.5 and 33.7 percent respectively. The economy continued to contract in 1993 with output falling another 28 percent (Table 1.1) and real GDP in 1993 down to about 40 percent of its 1988 level. Table 1.1: Real Growlh In Net Material Product 1988 1989 1990 1991 1992 1993 Agricuklre. including foresty 10.9 -13.0 -9.18 -9.9 -27.7 Industry 15.0 1.9 1.9 -7.4 -35.7 Oher 5.8 6.4 2.2 -26.8 -47.2 Net Material Product 12.1 -2.9 -1.6 -12.5 -33.7 Gross Domestic Product -28 Souwe: Star Stalisal Commite of Tajikistn. 1.7 Although all sectors have expeienced the decline in economic activity, the decline in agriculture began earlier. The agricultural sector, which has registered negative growth rates since 1989, fell by about 10 percent in 1991 due to cold weather and heavy rainfall early in the planting season. In 1992, the situation worsened as shortages of key inputs and eruption of civil war severely hampered production despite relatively favorable weather conditions. Output of almost all agricultural products declined and production targets for cotton, a key export item, could not be attained. Important items, such as silk thread and cotton fibers, declined by 56 percent and 67 percent respectively. The agricual sector as a whole declined 28 percent in 1992. 1.8 As Table 1. 1 shows, the industrial sector did not start to decline until 1991. Before that, the FSU fmnanced continued investment in the sector and funded ongoing projects. With the reduction and ultimate cut off of these transfers, as well as trade and payments system problems. industrial output declined by about 7.5 percent in 1991. The contraction deepened in 1992 and sectoral output fell by about 36 percent, contributing to the large decline in NMP. The construction subsector was hardest hit, declining by 73 percent in 1992. Service sectors also declined. Retail activity dropped 35 percent in  Background S 1991 and 68 percent in 1992. Road freight and passenger traffic decreased about 60 percent in 1992, and preliiinary estimates suggest another 50 percent decline in 1993, with rail freight expected to be only 33 percent of its 1991 level by the end of 1993. 1.9 Two main reasons for the sharp output declines reinforced each other. First, with the break up of the FSU, supply and marketing links under the interrepublican trade system deteriorated and eventually broke down, triggering the initial decline. Bilateral trade agrements between Tajikistan and the rest of the FSU could not make up for the loss of previously centralized trade arrangements, and given Tajikistan's dependence on importing key inputs, the situation gradually worsened. Disruptions in the flow of raw materials and fuel led to progressive reductions in capacity utilization rates. By 1992, a large number of factories were not operating at all. The drastic fall in real household income reduced aggregte demand and contributed to the decline in economic activity. Second, the advent of the civil war and floods in 1992 and 1993 delayed reforns and severely reduced the effectiveness of initial measures, introduced in 1991. In addition, the war and floods damaged the country's infrastructure, imposing serious constraints on the activities of productive units and preventing the development of a new system to take the place of the old one. Table 1.2: T2jldatamn Natinal Accounts Sumnary (percent of NMP) 1985 1986 1987 1988 1989 1990 1992 National Income Produced (Net Material Product) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 National Income Used 118.0 120.0 120.0 116.0 118.0 115.0 116.1 Consumption 85.0 94.0 95.0 89.0 96.0 98.0 91.9 Private consumption 78.0 84.0 84.0 79.0 85.0 87.0 83.9 Social consumption 10.0 10.0 11.0 10.0 11.0 10.0 8.1 Accumulation 30.0 26.0 25.0 26.0 22.0 17.0 14.8 Resource Balance e -18.0 -20.0 -20.0 -16.0 -18.0 -15.0 -16.1 aI Resource balance reprsents the difference between national ime produced and nationu income- used, except for 1992, whenr an actual trade deficit figure is used. Sources: Goskomstt, IME and Bank staff esfimates. 1.10 The lack of data on aggregate demand and its components makes comprehensive review of patterns and changes in national expenditures difficult. However, Table 1.2 provides a rough picture of Tajikistan s overall expenditur pattern. From 1980-85, Tajikistan maintained a relatively high negative resource balance because a large amount of external resources came in from the FSU. As the table shows, external resources from the Union climbed to 20 percent of Tajikistan's NMP in 1986 and 1987, and declined to 15 percent in 1990. Consumption over the 1985-90 period rose from 88 percent of NM!P to 98 percent, almost all due to the increase in private consumption, which accounted for 87 percent of NMP in 1990.  6 Chapter I 1.11 Since 1990, there are no consistent consumption estimates.' Nevertheless, preliminauy national income accounts suggest that real consumption may have declined in 1991 and 1992 by 22 and 40 percent respectively. Trends in monetary income and personal expenditures, retail turnover and wages, which also can be taken to indicate the evolution of consumption, point in the same direction. During 1992 and 1993, price increases surpassed these indicators by a wide margin, suggesting a substantial decline in real consumption. Real decline may have been partially mitigated by dissaving and the emergence of black markets. Based on a survey, the Govenznent estimates that black m.arket tumover ray be as high as 25 percent of total retail turnover. 1.12 lnvestment accounted for about 30 percent of NMP in 1985, gradually declining to 26 percent in 1988 and 15 percent in 1991. The initially high levels of investment reflect the capital- intensive nature of hydroelectric, infrastructure and other industrial projects. Lack of savings due to high levels of domestic consumption during 1985-91 meant that most investennt financing came from Union transfers. According to preliminary data, real investment fell by about 36 percent in 1992. There are two reasons for this. First, the external resources from the former Union abruptly ended that year. Faced with this revenue shortfall, the Governent started tightening its expenditures. Second, as a result of thc civil war, there was virtually no fixed investment in the second half of 1992. In 1993, budgeted capital expenditures, which provided the only source for enterprise investment, were further reduced to as low as 5 percent of NMP. The sharp falls in investment significantly contributed to the decline in the overall economic activity. 1.13 Except for 1988, domestic savings steadily declined during the 1985-90 period, reflecting the rise in consumption. Savings as a percentage of NMP fell from 12 percent in 1985 to only 2 percent in 1990. Since then, data are not reliable enough to make an accurate assessment, but anecdotal evidence suggests that dissaving continued in 1992 and 1993 as the population sold off assets to maintain consumption levels. Since the loss of Union transfers is permanent, Tajildstan must take immediate action to reverse the declining savings trend in order to finance new investment and take the initial steps necessary to put itself on a path of self-sustaining development. Employment ad Wsges 1.14 Offcial figures vary as to unanployment levels, with some figures indicating very low levels of unemployment. As a centrally planned economy, Tajikistan did not previously experience open unemployment because the State would employ almost everybody. For 1991, official data shows only 8000 people unemployed. In 1992 and 1993, official data show little change in the unemployment figure. However, anecdotal evidance, together with Taji.kistan's high population growth rate, 3.1 percent per annum, and declining output, suggest that unemployment is much higher than official figures. 1.15 From 1980-1990, wages remained fairly stable growing at an average annual rate of about 8 percent. Since 1990, wages have steadily increased, although these increases did not keep up with rising price levels, implying a decline in real terms. Goskomstat data indicate that average wages increased by 10 percent in 1990, to 207 rubles and by 64 percent in 1991 to 340 rubles. Wages rose throughout 1992, from 724 rubles in January 1992 to 4336 rubles in December 1992. The average wage 1. Ptior to 1990, Goskomsta in Mosww provided these statistics. Since then, this responsibility has been assigned to Tajikistan's Goskomstat, which has no skilled personnel to prepare such data in a national accounting framework.  Background 7 reached 14,317 rubles in August 1993. In the beging of 1992, the minimum wage was doubled, from 1000 rubles to 2000 rubles. To mitigate the effects of price rises, the minimum wage was again doubled in May 1992, to 4000 rubles and in October 1992, to 8000 rubles. However, with prices increasing at a rate of about 30 percent per month during 1993, real wages declined. Public Finance and Fical Policy 1.16 The state budget of the Republic of Tajikistan includes the Republican Budget, and covers eleven regions, five cities (including Dushanbe), three oblasts and some villages. There are four other main extrabudgetary funds: the Social Insurance Fund, the Pension Fund, the Employment Fund and the -Road Fund. Although these are funded from wages, the state budget covers revenue shorfall. 1.17 Under the centrally plamed system, the state budget was an instrument for attaining plan targets. While state enterprises operations were not included in the state budget, they accounted for about 20 percent of revenues and received transfers from the budget to finance their investmen. Thus, the stte budget accounted for a large part of overall economic actvity. The state's dominance in the economy is reflected by the high ratio of expenditures to NM, averaging around 65 percent during 1985-90. However, domestic revenues persistently lagged behind expenditures over the same period, resulting m a structural deficit of 17 percent of NMP on average in the second half of the decade. Union transfers more than financed the difference between domestic expenditures and revenues and kept the overall budget in surplus until the end of 1991. In that year, these transfers accounted for about 50 percent of total revenues. 1.18 Traditionally, the main domestic sources of revenue have been mmovcr, profit, and personal income taxes. During 1985-90, their shares in total revenues averaged 50, 25, and 8 percent, respectively. On the expnditre side, current expenditures averaged about 85 percent of total outlays, or 65 percent of NMP in 1985-90. The largest item, subsidies and tansfers, absorbed about 36 percent of all expenditures between 1985-90. Capital expenditures, financed by the budget, averaged 15.5 percent of all budgetary exenditures between 1985-90. 1.19 The sudden drop and eventual cutoff of Union tansfers after independence has led to major changes in public finances. Anticipating a lower level of transfers for the remainder of 1991, the Government imposed strict expenditure controls. Almost 70 percent of all budgeted capital investments were put on hold and funding for unfinished projects, particularly in housing, was sharply reduced. As a result, total capital expenditures in the budget declined to 2.6 percent of total expendiures in 1991, from 17 percent in 1990. However, social expenditures could not be adjusted. To compensate for rising prices, subsidies and transfers were increased, absorbing 55 percent of total outlays, up from around 39.4 percent in 1990. In real terms, however, expenditures declined as price levels rose 200 percent followitig the first round of price liberaliaion in April 1991. Nevertheless, owing to the severe capital outIay cuts, total expenditures for the year were below the targeted figure. 1.20 The 1992 budget originlly targeted deficits at 6 percent of expenditures to adjust for the permanent loss of Union transfers. At the same time, as part of fiscal reforms, the Government introduced value added (VAT) and excise taxes in early 1992 and eiminated tunmover and sales taxes. While these measures moved in the right direction, coupled with declines in production and trade, their immediate effect was to generate less revenue than expected. VAT receipts were 700 million lower than expected, while excise taxes brought in only 2 billion rubles of targeted 5 billion rubles (Table 1.3). Revaluation tax revenues were the only revenues exceeding planned amounts, due primarily to rising infladon.  8 hapter 1 Tae 1.3: TaJaInI SWte Budng, 1991-93 (in u:E1I of nuhks) 199 g1992 1993 Planned Budnel for the Year flra! acar original amended Total Revenues and Gns 5.457 17.441 74.352 14.021 170.113 TuhroverTax 955 112 - - - VAT - 4.300 32.00, 39.565 65.417 Excise Tax - 2.145 9.100 22.757 13.401 Sdes Tax 219 172 - - - Eterprise Profits Tax 604 5,398 1,879 19,455 43.947 blcwe Fom Puivazation - 434 100 100 1.412 Tax on Proflis of Cooperavs - 305 427 400 1,S78 Persa ncue Tax 333 1,634 5,363 8.,87 13.954 Sxte Fees. Loa Taxes and bIeomes 1692 230 320 328 2.109 Revahuaton of Enteqis Ivendtis 393 1.431 1.000 4,4S 9.848 Export Tax 1 43 320 160 1,316 InpotTaX 1 42 - - - Union Tansfers 2.543 - - - - Othr - - 7.569 - 17.131 Total Expediue 5.02D 37.094 14.570 255,549 326.532 Naioul Economy 1.315 18,142 46.1S7 48.775 117.051 ScandOw Cullor tivites 3.138 13.744 79.471 34.000 103.428 ducinron - 7.542 48.403 48.318 55.653 Culmuc - 581 3.093 3.425 4.310 Healtb - 3.611 19.419 19.858 34,29 Sports - 19 57 79 82 Aid for Singlc Molbs - 25 39 39 - Social Smcurity - 1.966 8.460 11,781 9.086 Science 18 196 I'M27 1,394 1.704 Ste Apponts and Coon 82 602 7.151 7928 17.726 Police 49 2.056 17.779 18.231 638 Defence - 255 14.463 28.664 24338 Coenao- - - - 4.500 35.862 Other 418 1,124 3.833 48.371 25.785 SuupkslDeticit 437 -19.653 -110213 -151.831 -156.419 As per t of GDP 3 -37 -24 -33 -25 Scuuc Maisty of Fbince. 1.21 Meanwhile, the outbreak of the civil war and rising ation caused expenditures to increase sharply. In part, the rise in expenditures reflected the Govermnent's efforts to mintai the populations living standards by increasing nominal wages and subsidies. hvestme expenditurcs have declined. The actual deficit was 19.6 billion rubles in 1992, accounting for 53 percent of expenditures and 37 percent of GDP. 1.22 The fiscal situation continued to deteriorate in 1993, with deficits at 25 percent of GDP. Revenues remained stagnant, in large part reflecting the effects of declining output. At the same time, prices increased more than 20 fold during 1993. With price controls on seven key items, the subsidies incrased the budget deficits. As a result, the budget was amended again in 1993. The original budget,  Bac-9p6md 9 which planned a 110 billion rubles deficit, was revised to 249 billion rubles. However, the actual deficit for 1993 was 152 billion rubles. Large deficit increase was caused mainly by new wage incrases along with subsidies, which started in August 1993 to cmpensate for price increases for bread and butter, and payments of arrears to bakery houses, arising from previous subsidies. Increased defence expenditures and flood relief also contributed to the rise in expenditures. 1.23 In the absence of ocher sources of financing, the budget deficits were financed entirely by NBT. This proved to be highly inflationary and its continuation would seriously undermine any stabilization reform. Current fiscal policy has also become an instment for financing consumption, particularly in the forn of higher wages and subsidies. The current fiscal policy is not sustainable and must be reversed. Serious efforts are needed to increase tax revenues and reduce expenditures to amounts in line with available resources. In the absence of fiscal adjustment, the Central Bank of Russia (CBR) may refuse to honor its commitments under the proposed mnonetary union with Russia, which will complicate macroeconomic management In any event, economic stabilization will not be possible if budget deficits are not brought under control. Monetary and Financial Developments 1.24 Prior to the FSU's break up, Tajikistan's monetry policy passively aoodated the financing needs of the annmal plan and the budget The overall money and credit conditions in the coumtrv were determined by the former USSR's Gosbank and depended upon actual mplementation of the plan. Policies were carded out by the Dushanbe branch of the Soviet Gosbank through the credit plan, which set out deposit and credit targets for the entire econmy, credit programs fbr the Stare banks and direct lending to state enterprises, cooperadves and individuals. Interest rates were not used to mobilize and allocare resources or to manage aggregate demand Hence, monetary policy did not play its role in the sen-- understood in market economies. 1.25 In early 1991, the Government took some steps to initiate refonns in the financial sector. In February 1991, the Supreme Soviet enacted laws founding the NBT and regulating banking and other financial activities. NBT was authorized to conduct monetary policy and supevise dte bandng systeuL However, reforms have not yet led to changes in the way resources are mobilized and allocated. While the banks have been given more feedom in their lending decisions, in practice, credit allocation has remained subject to a varety of controls aimed at supporting existing state enterpnses and pnonty sectors. Banldng operations are also heavily concentrated. At present, three former stae bank control about 96 percent of lending, while the Sberbank dominates mobilizing the population's savings. Since 1991, interest rates have remained highly negative in real terms and have been lower than Russian rates. 1.26 In September 1993, Tajikistan signed an agrment in principle only, with Russia to create a monetary union. However, the basic terms of agreement are still being negodated and the framework and operational arrangements for full monetary union with Russia are yet to be finalized. In November 1993, Kazakhstan and Uzbekistan opted out of the mble zone and introduced their own currencies. This cxposed Tajikistan to a massive inflow of old rubles, further increasing inflationary pressures. After monthly inflation rates of 33 percent on average during January and October 1993, consumer prices rose to 63 percent in November and 176 percent in Decenber due mainly to te influx of old rubies from neighboring countries. On Jamuary 1994, Tajikistan stoped using the old (pre-1993) Russian ruble as its legal tender, with the exception of small denomination notes which continued to be used to purchase bread, newspapers, stamps and for city tasport. Tajikistan obtained a loan of 120 billion rubles for the shipment of new cash rubles from Russia in Januay 1994. This loan carries an e.,  10 Chapter 1 ilnterest of L1BOR plus 2; repayment is expected to begin in June 1994, although Tajikdstan's full entry into a monetary union would forgive this loan. 1.27 As Tajikistan exhasted its credit with most FSU republics, interrepublican payments through official channels declined throughout 1992 and 1993. To avoid appropiating their earnings and delays caused by blockage of the interrepublican crespondent accounts, Tajik enterprises resorted to shipping curency, barter and maintaining new ruble accounts in Russia. The resulting sharp increase in enterprises' demand for cmurey and the use of currency for interrepublican trade has reuled in a currency shortage in the country. Table 1.: MaI Monetary Aggregates (u nionms or rubles) Dec 1991 Jun 1992 Dec 1992 Sep 1993 Dec 1993 Net Foeign Asses 16.7 12.424.1 676,150.8 1.173.2942 1.047.055.9 Net Domestic Assets 5,1179 21,919.8 -40,846.7 439,16L0 -50,704.2 Credit to Govenmt -5052 -967.8 706.6 100.009.4 202,103.0 Credit to Odter Governim -336.1 -9923 -1,674.2 -19,2082 -20,666.6 Credit to the Economy and Other Items, et 7,0291 4,879.9 639.879.1 -919962.2 -688.140.6 Credt to die Economy 6,884.6 26.702.7 71,916.2 467,183.0 633,680.6 Other Items, net 144.6 -21.822.8 -711.7953 -1,387.145 -,321,821.3 Liabiities 5,204.6 15,3429 35,339.7 334,126.2 540,3S1. Currency Outside Bns 2.1142 4.414.8 17,617.1 131.3722 175.4042 Deposits 3,090.4 10,928.1 17.722.6 202,754.1 364,947.6 Veleity of Broad Money 2.57 2.09 1.95 2.3 1.54 Nomna GDP 13,400.0 7,971.0 17,2S7.0 203,110.0 207,400.0 Sources: NIT. 1.28 According to official daa provided by NBT, domestic credit growth has been high. with one third allocated to finance the Govermen budget and two thirds to state entprises. Credit to Goverment increased from 707 million rubles at the end of 1992 to 100 billion rubles by September 1993. Between September 1993 and December 1993, credit to Government doubled to 200 billion rubles. Credit to economy, mostly enterprises, also increased dramatically - about 9 times relative to its 1992 level (Table 1.4). In line with these developments money supply has been increasing since 1991. By the end of 1992 and 1993, broad money increased by 7 and 15 times respectively, which was more than broad money increases in Russia. Prices 1.29 The Government initiated the process of price liberalization in April 1991. At that time, price controls on a limited range of goods were lifted and the prices of goods that remained under price control were raised significanly. On January 10. 1992, a second round of price increases on a much wider scale took place. Price contols on 80 perent of goods were eliminated and only eight items of industria goods and fiftee items of consumer goods were r:t liberalized. These controlled item represented abot 15 percent of goods and services. Since then, the Govenment has fiuther reduced price controls. As of the end of October 1993, only 2 percent of the number of goods covering seven  Background 11 items re.i undcr price controls Crable 1.5). Fi12;Rtl&Woe ePreInx hose seven items stl rep a significant 2: Retail Who Poe Index portion of consumer expendib, however, and continued control of these prices would wormen the budgetary situation. 0 / 1.30 When Taildstan was part of the U . Soviet Union, prices were severely repressed. so Official figures show a very modest infaion rate of 4.4 percent in 1990. However, since 1991, prce increases have begn to accelerate and t __ S I follow a patern similar to that found in other . _ FSU ountries, which depends on the pace and -*w -w_ magnitude of Russian price liberlzation. It is _ esmated tt the iial round of pnce liberalization resulted in an inflation rate of 95t1 pee in 1991. In January 1992, after Russia raised its prices, Tajikta experienced an inflation rate of more than 200 percent in that month alone. Price increases continued fhroughout 1992. Preliminary Table L3: LIt of Mai Cnsume Ptoduts and Sevies Subjec Slat Pike Reguaton kern Date of Liberaliato Flow (CrdelIudl) * Bread * Wilk. Dir Swr-Milk Products. Fa e Curds * Lomcly Pod M Mah 31, 1992 Baby Food. including nutritio conats June 1, 1992 Food Salt March 31, 1992 Sugar Ju 1. 1992 Vegetable OH October22 1993 odkac Spirit November26, 1992 Matches December27. 1991 Medicine and Medical Tools Febna 1, 1992 Technical Means of Prophylctic Trmnt and RehabjaiSon of Disabled February 1. 1992 Ptroleum, Diesel, Kerosene * Fud. Fiewood. Gas, Oil July 6. 1993 Utilities S Housing Fee. induding dorm fee Transport and Communications Services * * Indicates prices undr Govenmen conol Sauce: Miny of Econoy. data Cable 1.6) show an inflation rate of about l400 percent in l992 in terms of reail prices. The monthly inflation rates averaged about 30 percen between January and October 1993. However, inflation rates increased to 63 percnt in November and 176 percent in December due to the ianux of old rubles finm several neighboring countries when they introduced their own currencies in the last two months of  12 Chapter 1 1993. Between December 1992 and December 1993, prices inreased more than 20 times, measured in terms of the Consumer Price Index. Foreign Trade Table L6: Monibly anges in Retail and Wholesale Prices L31 Tajikistan has inherited an Year Moab Reail Price Wholesale Pice economy that is highly dependent on trade and vulnerable to eternal shocks. By 1990, 1992 1 213.1 136.9 merchandise exports and imports accounted for 1992 2 73.1 260.2 36.5 percent and 56.2 percent of NW. 1992 3 12.5 7.5 respectively. Iterrepublican trade accounted for 1992 4 87 57.8 89 percent of total exports and 81 percent of total 1992 6 13.4 7.1 imports in 1990. Such a high share of trade does 1992 7 13.0 42.8 not reflect the openness of the ecnomy, but 1992 8 17.5 10.6 rather, the interdependency of FSU economies 1992 9 IOA 67.6 due to pronounced regional specializion 1992 to 8.0 6.1 imposed by centra planing. Tajikistan's foreig 1992 11 6.8 6.6 1992 12 13.6 13.1 trade is characterized by a limited range of IM 1 19.0 146.1 products. Alumium, raw cotton and etcile 1993 2 24.4 832 products, make up about 60 percent of its 1993 3 34.6 50.0 exports, with the rest mainly fruts and 1993 4 63.9 415 vegetables, silk, marble and hides. The country 193 6 3.9 16.2 imparts a large part of its energy needs - 1993 7 31.8 17.9 particularly petroleum products - almost all 1993 5 43.0 23.3 manuhctured coner goods and, increasingly 1993 9 36.4 13.1 during the last two years, grain It is estimated 1993 10 25.1 74.8 that between 1985-90, Tajikisran cuent ac t 1993 i 63 24.3 deficits averaged about 18 percen of uW. In 1993 12 176.9 35.8 part, these large and sustained deficits reflected O GosCoosa cetrally planned development policies that required substnt imports of capital goods and were financed by Union transfers. 1.32 The external shocks, civil war and natural disasters of the last two yea esulted in Table L7: btleal Trad 11-3 (n mUon df large declines in trade volume. A sharp collapse of output, pardcWlarly in 1992, also contributed to 1991 19 declining trade volumes. Tajildstan's inability to - - honor some of its trd agreemens led other FSU Eart 3.944.6 37.093J countries to reduce their shipments to Tajilistan Balm= 276.9 46.917.9 and insist on settling interrepublican correspondent accounts before issuing new trade SOUwcC GLoscasb credits. 1.33 Official data, although not reliable due to measurement problems and the multiplicity of exchange rates and prices. indicate that tade has been contracting. According Goskoma, in 1991, imports totalled 3.67 billion rubles, 84 percen from FSU and 16 percent fiom non-FSU sources. Exports amounted to 3.94 billion rubles, 79 percent going to FSU and 21 percent to non-FSU, creating a small  Background 13 FI.tS: Sutm of Expats 1990 (YakS Cams In ICmd prisms F4l:Stulhn af Impart 1990 IW _" b 10110sd6 pries cetala ~ ~ ~ ~ ~ ~ ~ au amew fluuiwy 27 f I surplus of 278 million rubles. Howeer, the surplus was Talme 1J.: Ralc or pans (in mama of US due to the shar fall in imports than improved export dolgn) performance. Trade balance deteriorated in the following im years. Official figures indicate that, in 1992, exports were about 37.5 billion rubles, while imports were about Tool Expons 418 44 bilion rubles, resulting in a trade deficit close to 7 Tot IWnyn 637 billion rubles in 1992. Relative to NMNP, boti exports Trade Brn -219 and imports fell in 1992. For 1993, total exports and NetSevices -6 imports were expected to be US$418 million and US$637 Net le= -6 million, respectvely, resulting in a trade deficit of about Net Non4acwr Senices 0 30 percent of GDP. counAcount -22s 1.34 Official data also indicate a maded et Lon-Tae Capitl Taow change in the direction of trade in 1992 and 1993. Trade Blw. 50 figures provided by Goskomstat indicate that the share of Comrpondeuc Acu 175 FSU exports, which had been 79 pecent in 1991, D F 0 declined to 45.3 percent in 1992 and to 34.7 in the first Change in Resrv 0 half of 1993. This men that almost 56 percent of all exports in 1992 and 65 percent in 1993 were shipped to Memorandum Ieni non-FSU countries. Similarly, the share of FSU imports CunAcnt/CDP(e) -33 declined from 84 percent in 1991 to 54.2 percent in sowcc no. 1992. Cotton and aluminum exports to non-FSU counties appear to bave increased somewhat. However, in the absence of volume data, the extent of diversification suggested by official figures must be intpreted cautiously. Non-FSU trade data is reported in rubles by enterprises that convert their forei exchange earnings using an exchange rate close to the market rate, which produces a high value and high share for non-FSU trade. It is therefore difficult to detenrine accurately the actala volume of non-FSU trade.  CHAPTlE 2 ECONOMIC REFORMS AND EXTERNAL FINANCING REQUIREMENTS 2,1 A comprehensive economic riform program is miperative to overcome Tajilkktan's current economic crisis. Policies directed toward onomic stabilization and stuctral reforms are fundamental prerequisites to securing external financig and transforming Tajkistan's economy into a market-oriented one. Ultimately, the reform program's success will hinge on implementng strucural reforms and the necessary sectoral trsformaton The enling evronent for developing the pnvate sector should be established as soon as possible to ensure that this sector becomes the driving force in the economy. 2.2 Political stability and security are precondidons for implementng a successful economic refrm progmn. It will also be essendal to sequence stabilization and structural reforms in an orderly maner. Inital reform measures should include lieralizing prces, phasing out stte orders and reducing the budget deficit. These steps should be immediately followed by acceleraing privatimon of small scale entrises, developing the legal framework for private sector development and initiating a comprehensive privatization and restructuring program for large state-owned enterprises. Since the civil war and recent floods have crippled the economy's infrasue and a large part of its productive capacity, it is essential to reconstruct the infrastructre at the same time that specific refomr measures are implemented. Reform Program 2.3 As discussed in Chapter 1, Tajlkstan has experienced sustined output falls since 1989. By the end of 1993, the eountry's real GDP is expected to be only about 40 percent of its 1988 level. This magnitude of output contraction uodesres the serous nature of the collapse of the old production arrangements, the pemanent loss of Unix transfers and the impact of war and floods on the economy and highlights several important reasonm for the Goverment to implement an economic reform program, provided poLitical stability is attained. First, it will not be possible to rebuid the economy, which has suffered such great damage and had so much of its structure destroyed, by reurning to cental planning, as the old Union no longer exists to provide the necessary transfers. Second, in order to lay the foundations to develop a market-oriented economy, the economy must be stabilized and reform measures adopted that reallocate factors of production toward their most productive use. Third, design and implementaton of a refom program will be essenta to atract the external resources rquired for the economy's rehabilitaion. 2.4 The Government's proposed reform agenda does not lend itself to speedy economic refem Particularly in the enteprise sectr, it fails to promote medium scale privatization plans and enterprise restructuring programs. Although it envisions establishing small-scale private businesses, adequate consideration has not been given to developing the private sector or creating the enabling business environment required to operate small businesses. Since Tajistan's small business sector is severely underdeveloped, the reform program should give priority to promoting it by providing the necessary legal and institutional famework The economic refonn program should also establish a stable macroeconomic enviromnent and nurture sustainable economic growth through effectve monetary and fiscal policies. Prospects for the succsful stur trnsformation and stabilization of Tajikistam's economy also depend on the Government's ability to: (i) restructure the legal and institutional framework so that it is conducive to a market economy and private sector development; (i) restrucure and pridvatize  16 Chapter 2 state owned entprises; (iii) establish a trade policy compatible with output recovery; (iv) reform the financial sector; and (v) initiat a social safety net to protect the most vulnerable groups from the inevitable hardships of the transition period. Stabilization Measures 2.5 Fiscal Polcy. The unstable political and economic enviromet has caused the fiscal sitnion to deteriorate markedly. Public finnce has rapidly worsened and initl budget targets have not been attained due to the civil war and natur disasters. With normalization of political and security conditions, the Goverment should implement policies to stablize the conomy. As an essential element of stabilization, fiscal policy should aim at controlling the fisl deficit. The fact that Tajikistan is in the process of completing negotiations with Russia on a monetry union will impose certain constraints on fiscal policies in Tajikistan and require policy coordination with the Russian Federation. If these constraints are not being adhered to when the monetay union is established, and the Russian Federation finances large budget deficits for Tajikistan, the Govemment would bave little incive to implement tight fiscal policy. On the other hand, if under the agrement limits are imed on money and credit expansion and the deficit is rduced or if Tajkisln decides to introduce new currency, serious efforts will be needed to expand tax revenues by broadening the tax base, increasing certain taxes and strengthening the tax collection process. In the latter cases, the authorities mnust also tighten expenditures and enhance the efficiency of Govermen services if fiscal policy is to be effective. 2.6 Monetary Pofty. As noted in Chapter 1, Tajlkstan has ratified the agreement on monetary union with Russia, but the tenms, framework and operational arrangements stll are being nalized. Under the monetary union, macreconomic management will depend to a considerable extent on coordiating monetary policies with the Russian Federation and hamoning reserve requrements, bank suersion and other prudential regulations to estabhish equal interest rates wih Rui In fact, the Central Bank of Russia would conduct monetay policy and determine monetary conditions in Tajikistan. Under these conditions, it would b essenfial that NBT adopt management and operational methods necessary to coordinate with CBR. If Tajlksn is to have an input in formulating policy, it will need to significantly improve its instittional and implementation capacities. Technical assistance from the IMF will help strengthen the NBT's institutional capacity. On the other hand, if Tajikistan deides to introduce its own currency and pursue an independent monetary policy, it should do so with caution and assistance from the IMP, paying special attention to the timing of introducing the new currency and making sure that strong structurl and stabiizaion measures are already in place. Structural Reforms 2.7 Systemic change from a centlied planned economy to a market economy requires political stability and sustainable and consistent reform that encompasses both short- and medium-term measures. Simultaneous progress m various program components is necessary for a successful, efficient and equitable transition to a market economy. In the short run, the infrastrucntre must be reconstructed and improved to support the adjustments and :afeguard a supply response in the productive sectors. 2.8 Legal Framemwro. The transition from a command to a market economy will require significant changes in the legal and institutional framework. Sustinable development and, in particular, increased private sector involvement in economic activities can only be secured if an appropriate legal system is put in place. Although some relevant laws have been enacted, they reflect concepts of property rights, privatiation and entrepreneurial venatres that were prevalent at the very beginning of the FSU's  Economic Reforms and External Financing Requirements 17 econonmic transfornation. Some laws have gaps in their coverage, others remain inoperative becuse of lack of implementing regulations. Moreover, they have been considered in isolation from one anther, creating a potential for inconsistency or conflict. Much needs to be done to integrate legal and adinimstrative institutions conducive to market activities. Important steps include: puting private ownership and business activities on an equal footing with public enterprises; defining property rights clearly; promoting competition through anti-monopoly legislation; and encouraging new private firms through company and foreign investment laws. Immediate action is required to brWg the various legal reform activities into a comprehensive and systematic framework. The various branches of Govermnent, as well as the Supreme Soviet, should all participate in the lawmaking process to facilitate development of an effective legal reform program. 2.9 The Government should accelerate privatzation of the small enterprises and a schedule of small scale enterprises auctions, focusing first on Dushanbe, should be established in the near term. The Government should establish clear and realtisc ipletmenon plans for pnvatzng medium and large enterprises in the medium term. Individual proposals for privating large scale enterwises should be developed and the insfitutions responsible for carrying out prvatization should be strengtiened. Prvatization alone will not promote efficiency, however, and needs to be accompanied by a conmpetite and conducive environment for private sector development 2.10 Enterprise Rtuctng. The Government should defie a set of clear strategies to iprove the performance of enterpnses that will remain under state ownership. The success of enterprise reform hinges on adoptig hard budget constrais and i le measures to reduce the flow of interenterprise arrears. Enterprise restructuring should focus on rationalizing production and enployment, improving accounting methods and giving management more freedom to create new business methods. For non-viable enterprises, the Government should develop socially acceptable critea for closure. Subsidizing positive value-added enterprises suffeing from cash flow problems should be considered only within budgetary constaints. 2.11 Attracting foreign direct investment to facilitate private sector developmet and dontribute to capital formation is crucial to developing Tajikstan's economy. Natual resource development offers the greatest possibilities for foreign investment. Tajikdstans natural resources have not been well developed due to lack of capital and know-how. An enabling and conducive anvironment must be established to prmote private sector development and attract foreign investment in this area. Specifically, the essential prerequisites for negotiating investmnt agreements need to be improved, there is currently a dearth of information about the condition of local enterprises; sectoral analyses are unavailable; and financial statements meeting international financial standards do not exist. 2.12 Fmancial Sector Reform. Financial reforms are an important element of a successful transition program. Focus should be on designing an efficient financial system to moblize savings and channel them to the most efficient sectors of the economy. In the short-tm, a credit ceiling might be used to control the volume of the credit. The medium-term objective should be to reduce the NBT's intermediating role and the central direction of credit to specific sectors. It is also vital to develop conmnercially oriented bankdng guidelines and supervision capabilities in the NBT. In shifting to a commercial banking structure, suitable rules for supervision must be put in place. If the monetay union with Russia materializes, interest rates will be the same as in Russia. If national currency is introduced, adopting real interest rates should be a goal. Iniatives should also be taken to improve credit assessment, positive risk management skills and accounting systems in commercial banks.  18 Chapter 2 2.13 Trade Polides. Tajikistan's economy is highly dependent on trade. This does not imply opemness of the economy, but instead reflects a division of labor based on FSU policies and the Gosplan. Tajikistan's trade regirn. involves considerable Govemment intervention, including a system of complex licenses and quotas, barter agreements and an enhanced state order mechanism that are not compatible with structural refonn objectives. To help output recovery, the Govermnent must diminish its role in international trade and the current intricate procedures must be simplified. As an overall objective, trade policy needs to promote industries with potential comparative advantages. Trade with the neighboring countries should be strengthened and exports to non-FSU countries should be developed. Tajik exporters should pay attention to marketing factors such as quality control, distribution, pre-sales and after-sales services and services of embassies and Government representatives abroad should be used for the promotion of exports. In general, the Govermnent should indicate that the present commad and control system in trade is transitional and announce a clear timetable for allowing the private sector to assume a larger role and greater control. 2.14 Social Saety Ne. The Government wants to make every effort to protect vulnerable groups against the adverse impact of economic adjustment. After implementing economic reforms, ineffiient enterprises most probably will fold faster than efficient ones emerge and considerable time may elapse before the reform measures manifest net positive results. During this period, the Govermment should protect vulnerable groups against the most severe consequences of economic reform. However, because of budgetary constraints, the past system of generous social benefits should be rescinded and replaced with special assistance programs that target only the most vulnerable groups like targeting the per capita payments to compensate for rising bread prices. Medium-Term Outlook 2.15 The acute econonic crisis and the extent of required adjustment make a strong case for switching to a market economy as quickly as possible. As previously indicated, the authorities have prepared a reform program that includes some elements of stabilization, as well as structural reform measures that are currently being revised. The development prospects discussed below assume that the Govenmuent is strongly conunitted to the reasonable stabilization and structural reform outlined in the previous section. 2.16 There has been some recent progress made in resolving the internal political conflict. These included: Govermnent efforts to negotiate with the opposition; public debate of the draft constitution before the July 1994 referendum; Presidential elections planned for October 1994; and the establishment of parliamentary conunissions on human rights and political prisoners. However, under any circumstnces, assessing development prospects is difficult. Many factors may affect Tajikistan's economy in unpredictable ways. One key issue is political instability and the continuation of civil strife, since it is not yet clear how the political situation will evolve notwithstanding the recent developments. There is also significant uncertainty as to how fast the economy's current bottlenecks can be reduced, particularly with regard to state enterprises and private sector development. The amount of foreign exchange the country will receive from exports and foreign aid remains unclear. Another complicating factor will be the shortage of skilled and technical personnel. The country lost some of its best people because of the civil war, which will adversely effect the development of institutions to support a market- based system.  Economic Reforms and Extemal Financing Requirements 19 Development Prospects Output 2.17 With political stability and improved security conditions, economic reform is expected to help slow down the output decline and set the stage for the ultimate resumption of growth. If political stability is achieved and ecoromic reform is begun immediately, the following projections about GDP and its components, presented for illustrative purposes, may be realized. After four consecutive years of decline beginning in 1989, it is assumed that the decline in GDP may slow in 1994, which will be called year 1 for illustrative purposes, to 7 to 5 percent. Output recovery is not expected to materialize until the end of year 2 due to negative growth in the industry sector. Agriculture is expected to respond quickly to the new incentives of reform such as price liberalization. As reforms take hold, GDP could be expected to increase by 4 to 5 percent in year 3. In the following years, it is anticipated that the industrial sector could start to recover and that the agricultural and service sectors will become the leading sectors. Output could grow by 7 to 9 percent in year 4 and about 10 percent in year 5. However, taldng into account the sustained large declines since the late eighties, at these rates economic expansion could restore real GDP in year 5 to only about 50 percent of its 1990 level. Table 2.1: Projection of Key Economic Indicators (percentage of change) 1993 Year 1 Year 2 Year 3 Year 4 Year 5 GDP -2B -7 tw-S -Ito 1 4 to S 7 to 9 9 to 11 Agricnltre -10 3 bo5 S to 7 6to 8 to 10 10 to12 Idustry -32 -21 to -19 -11 to 9 O to 2 3 to 5 4 to 6 Services -37 -2w 0 0 O 2 5 to 7 10 o 12 13 to 15 Source: World lBank staff. 2.18 Over the medium-term, the agriculture sector is expected to grow steadily and provide the impetus for supply response to restore growth in de rest of the economy. In 1993, because of fiul shortages, floods and civil war, agricultra output declined by another 10 percent. As critical import shortages are eased and structural refonns, especially price liberalization, begin to be implemented, agricultural output is expected to increase by about 3 to 5 percent in year 1. As reform deepens particularly in the areas of producer prices, state orders, distribution and ownership of agricltural assets, growth is expected to reach 5 to 7 percent in year 2. The culative effect of these structual reforms should be felt in year 3, increasing yields substantially, and leading to 6 to 8 percent growth in the sector. Provided that the Govemment continues its reform policies, agricultural output could grow by 8 to 10 percent in year 4 and 10 to 12 percent in year 5. 2.19 The industrial sector, comprised of manuf , construction, mining and energy production, declined about 32 percent in 1993 due to continuing shortages of raw materials, spare pxts and energy caused by the collapse of interrepublican trade arangements. It is anticipated that intowing reforms, which wil start the process of reallocating resour, will result in a furth drop of about 20 percent in the sector's output in year 1. However, rapid small scale privatizaion and relaxing central  20 Chapter 2 controls over industry is expected to slow the sector's contraction to 9 to 11 percent in year 2. Assuming that trade agreements with former FSU republics, particularly Russia, are reached and that the Government presses ahead with privatization and enterprise corporatization, industrial output will likely stabilize by the end of year 2 and start growing in year 3. Efforts to attract foreign direct investment, establish new small and medium-sized companies and upgrade technology, particularly in agroprocessing, is further expected to increase output by about 3 to 6 percent in both year 4 and year 5. 2.20 Since the service and trade sectors were underdeveloped under the centrally plamed economy, reforms are expected to lead to rapid supply responses in these sectors. Tajikistan has a relatively well educated human resource base and strong entrepreneurial capacity. Provided that the necessary legal and regulatory framework is put in place and financial sector reforms are undertaken, the service sector could be another fast growing part of the economy by year 4. Encouraging the service sector could also serve to limit the departure of skilled people, particularly Russians and other minorities. Investment, Savings, and Consumption 2.21 As previously indicated, investment has declined from 26 percent of NMP in 1988 to 15 percent in 1991, reflecting the loss of Union transfers. While there is no consistent estimate for 1992, all indications are that fixed investment fell further. Considering the impact of two consecutive years of floods and the 1992 civil war, Tajikistan's investment needs are substantial. Sectoral reviews undertaken by the World Bank as part of an Emergency Reconstruction Program indicate that there are urgent needs, particularly in agriculture and flood protection, transport, telecozmnunications, housing, and the power subsector which total about US$116.4 million, of which US$97.9 million is in foreign exchange (See Box 2.1). These investment requirements relate only to the Emergency Reconstruction Program; aggregate investment requirements are much higher. 2.22 Tajikistan will need to define a core investment plan that can be financed in part by extemal borrowing and in part by domestic resources. Investment will have to be conFuied to essential minhimums until national savings start to recover. Provided that the Govcrnment remains committed to reforms, a limnited recovery of investment may be expected to materialize in year 2 of the projection, primarily in infrastructure repairs, housing and construction. It is expected that during the projection period, investment will not reach to pre-independence levels. 2.23 Private savings start from a very low base and are expected to recover slowly after adjusting to lower income levels. Since the population will try to maintain previous consumption levels, it is expected that savings will not start to rise before year 3 or year 4. While revenue generating and expenditure control methods would improve public savings, these will continue to be absvjbed by social expenditures for some time, leaving a negative balance. With progress in privatization, price reforms, better targeting of social assistance and tax reform, public savings could improve. 2.24 As discussed in Chapter 1, while post-1990 data are not reliable, official figures indicate that consumption declined by 22 percent in '991 and about 41 percent in 1992. Although there is no data for 1993, anecdotal evidence suggests that it fell further. Such sustained declines in consumption must be reversed if the population is to support reforms. Since, in the absence of large foreign assistance, the economy is not expected to start growing before year 3. it is not likely that consumption will increase in real terms before that year.  Economic Reforms and External Financing Rquirements 21 Trade Prospect and Exenal Fiancing Requiremeats 2.25 Due to insufficient information, it is extraenely difficult to project the country's trade prospects and financing requirements. The following projections assume that reforms are introduced in the base year 1994, which for iliustrative purpose will be called year 1 of the projections. The projections indicate the evolution of key macroeconomic variables for years 1 to 5 and thus are illustrative and subject to change. Over the medium term, Tajildstan's exports will be dominated by cotton and aluminium. It is assumed that the possible dosing down of the aluminum smelter will not change estmates of Tajikistan's current account as increases in eports of electicity and reduction in imports of raw materials used in the smelter would compensate for the exports of aluminium.. Based on sectral reviews, if reforms are implemented in year 1, exports of these two items are expected to be around US$200 million each in this year. In the same year. total exports are estimated to be about US$530 million. As the effects of reform start to take hold and the economy stabilizes, exports are expected to increase to around US$597 million in year 2 and grow at an average anumal rate of about 3.5 percent per annum until year 5. Total exports could average about US$650 million per annum during the years 3-5. 2.26 Over the medium-term, it is anticipated that energy imports will dominate all other items. In year 1, it is expected that imports of petroleum and related products wil amount to about US$215 million, although this is the largest single import item, it is still US$185 million less than the Government's esdmate. Natural gas imports are anticipated to be US$100 million in year 1. Grain imports will be the second Lagest item and are expected to reach about US$170 million in year 1, grdually declini;g in the following years as a result of inceased domestic production. Total imports for year 1 are expected to be around US$692 million. As the economy stabilzes, imports are projected to average about US$ million during the years 2-5. Tab L2: Me&a-Tn PeeJes lesot Exterd Ibanag Rhqiirmfl On U ia) YeC I Year2 Year3 Ycar4 YearS Lower Upper Lower Upper Lower Upper Lower Upper Lower Upper 1993 Bound Bound Round Bound Bound Bound Bound Boun Boun Boud Totl Financing Needs 225 264 293 275 303 290 320 301 332 2S6 315 Non-inter Cumnt Acoun -219 -L5 -171 -177 -196 -173 -191 -218 -241 -215 -235 Debt Service Amonizadon 0 -90 -99 -61 -68 -86 -3 -38 -42 -28 Net [nrest -6 -17 -V9 -19 -21 -23 -2S -35 -39 -3S Changes in Resms 0 -3 -4 -18 -20 -9 -10 -11 -4 Tool Fhmncing Sources 225 264 293 275 305 290 320 301 332 3L1 Foreign Dirctlnvesmnen 0 9 11 9 11 16 17 20 21 27 Multam Flisncing 0 0 0 0 0 49 54 40 45 57 63 Bilatel Fuizaniug 225 2S5 212 266 294 225 249 241 266 206 225 Note: The rnges slect unceaindec aummd die midpoint of each kem ow alurnadve polt senaros Source: World Bank saff. 2.27 The export and import projections discussed above are expected to result in a cmrrent account deficit (excluding net interest) of about US$162 million in year 1, which correwponds to apprxmaely 23 percet of estmated GDP. In toe following years, highe outu growth rates should  22 Chapter 2 cause current account deficits to grow to about US$250 million in year 5 or about 27 percent of GDP. In that case, the financing needs could range fom US$Z70 to US$350 milon for yeas 1-5. Box 2.1: TaJiOdan Emergeny PRecontructio Program Tajilsan suffered a short but disrous civil war during the second half of 1992. To addition. scvere flooding occurred in the springs of 1992 and 1993. Damage from dtese disasts was umjor. Tbe relatively densely populated southwest coner of the ounty has been by far the nmst affected. Over 850.000 people (about 1S percnt of Tajismn's popuaioi-iwert displacd and abot300.000 lost their homes. lnpon pas of the coumrs infrastu wer destmyed or vrly damaged, incluing about 600 k of rcds and 165 brie, over 200 km of flood proection dikes, irration system of about 39,000 ha of agriculturAl land, rainsforme - substions and abot 1.100 km of powr lies. andover5.000 telepo line. Publicserviyces, mainydhealth and educatin, also-: sdfred morlosses About 80 bealth care cean over200 schools w ptcar affec.. addi may i and public serces fes wee lood, with major losses in equipment and parts ani supplies.- The Govenme has -en umerus measures to rcconstrct eiy infrastructure ad to rest ore ervie -Most of these efforts have been efficierl coordind and nmnitored b5y th Star Commissio on Emegency Sibtin (SCES). -Accoing to its data, abu pzl load br b paired 66zsm Ite biinc -; -d d Rubles 60 bfllo have been spent so far. The Dushanbe-Kbojan road has beer reaie jmd sum key boalenecklivebeen eliinate. According to icplete SCES date about 45 km of flood protcion dikes, 20 bridgs, and 1701km of roads have eun rd. At the Governmeu(s requst, a mnuldt-s l missiom frm te WohId Bank visted Tajksninm Octber 1993 to prepan Emergency Rec rtion Progrm (P joidnty with de-Govmes exper:t. Alough tbheare veq.lageneds for habilitti and moda tion in all sects of Tajin's econmy, te missions work was maiy liid tD eeds stemming fom te 1992ad 1993 disasters. Only in vry few areas (mainly belth and agriculture,-where shortages could havc disastrou s on the populazion ad.ie economy) broader needs were duhedin theERP. lTh-ER?was2Lalsoliitedtio emergency actiiies, ir.e. those which can be filly completd wih two to three years. The missio found tt high poioy reon _oneeds a_mtd to USS16Amillion, of whichUS$97.9miion was in- foreign echange. A brief descripdon of the ERP by secto follows: (I Ariculbr and W MnamuL The ERP provides for ut 10-fam uactosnd spare pmr:forifanrm -- machinery and the supply of agrocherals to satisfy essena nds to rso the capaciLy of stae farms i the souenpan watof the- country. T ERPaso iudes provinforcivil wos equmet spar pans pmps,onorsant trial su as reorcing se to arry out the im portat repirs still reqied on about 200 km of flood protcion dikes and on die irrigaton sysms of about 39,000 becs of agricutual lAd. (ii) Education and Trainin. he ER pwvide mosty for r ctr schools and supping esntial tahg** equipmt and materials. (iin) Health Given dt the shortage of supplies is a najor cause of the heald care emergency now deveoping in Tajilkisan. the ERP icbudes vaccines and essent pbamacetcals for about a year for most of the populaio It also includes equipm and spare parts so reptce some of the mafte lost in tc war and floods. as wel as some importnt equipment redered usekss by lack of maintance. (i) Power. The ERP includes spar panm and sAplies for the mai hydro power plants, rehabilitation of te Dushaube dtrmal plan taform breakers and spar pars to repair dt ansmission sysm. overead lines, tansformer ard other supplies t rieconstruct the distrbuton syern in the southen regio. teecomnicaos ad tanspot equip t and spplies o faite genrl operatin, and an investme planning study. (v) Oi and Glas Prduction. The ERP provids ir pumps. elecic mooxrs and odter equipmnt and supplies to re the producmity of wells in the Beenyak od and gas field wo at leas te 1991 leveL (vi) Teleconnurmcmnons. The ERP includes tdephonc cablcs and mateials t reconstut dhe cable distribution network for 47,000 kn-pair of tephone lines in Dushanbe and Kurgm-Tyube. It also includes spe pars for telephone exchanges and miscella_eus equipment (vii) Roads. Th UP inmcdes civil works equipment spare pans. workshop equipment frel. bitmen, steel and odter matrials for repaing 592 kmn of rads and 165 bridges. cont'd.  Economic Reforms and Externa Financing Requiramnts 23 1Ds 21 TWan Emegncy- Rammtrun fropm (cmtd'4 - -viii) - Houssind. Toepand ondsuccesoNiUNECEhoug prgrIhe ERPiindesthprovsion of onsmdon mateia (moasdy rooig dsn a!tinber fobout 00vill uts)y o el dispcace poplaio of due Smutuhwest=ad Centa gions~ to recnstnuct thidrhonu.' -7~ elw ..s..a. c f . .. . . . . .. , ;. . , .,,......................... :,,: : -' ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. -!;=........-. .= Agnadmr and Wate Mainagement Ag-culift 0.3 5. - ;- 5.8 Hoad PRon - 5 10.4 15.9 - Mpdor.. - - -- - -3 - 26 . 3.9 EMducation an! Trainin Eucafi,n ... . LO :. . Trainn 1.0 9.0- 10-0 .eId: - = - - - -- - . O.S . . : J.0-. 83 Power . - 2.9: . 14.8 ... . i7.7 Oilandf Gauducdou .,,, , 0.1. ..Z .0.5 0.6 Telecon muicatio- * .0.6- -. 3. .. 4.0 -RaD: : 44:- - 18:2 22.6 s=.9,,^.i am , -: .:S0.. iS.7 .07 Imple ima& (CMU). - 0.2 - -*1 Total -: - - .:973.9 : 116A4 Soure: World ank-staff amnates. 2.28 The country 's develoment prospects will not be realized if the Government is unable to mitroduce the economic reform program outlined above. For that case, the process of reallocatig factors of production would not start in year 1 and adjustme in the industrial sector would be delayed, severely limiting the supply response of the econmy. With continued state orders in agrculture, tight control of production and inadequate supplies of imported inputs such as f:rtilizer, agriculumal output would not be anticipated to recover. Industria sector adjustmt would also be delayed. Without the necessary legal and regulatory frmework it is expected that the service sector woudd not resume growth. Delayed reforms would caus Tajikdstans exports to stagmte while its import requirems would continue to be high. Lower production from lack of inpts and continued centaized procurement would limit cotton exports. Since Tajikistans imports are made up mostly of petroleum, natumal gas and grain, the decline would be limited despite falling gowh rates. Under these conditions, Tajilsta's exrnal fiancing requirements would be very large and in the absence of a stabilization and strual reform program, such a high financing requiremcnt could not be met and there would be little direct foreig investment  24 Chapter 2 Creditwortbiness 2.29 During 1993, Tajildstan signed the zero option agreemaet with he Russian Federation. This means that it did not inherit any debt from the FSU era, except for unsettled correspondent account balances with FSU counties. However, the exact amount of these balances - and particularly their termIs for settlement - is difficult to determine. The Goverinent is in the process of negotiatng with its FSU parmers on these issues. At present, there is considerable uncertaint as to how to value these balances, sice it is not clear whether these debts wil be paid in goods, hard currency or new rubles. 2.30 As anew independent ste that lacks any previous credit record, Tajikstn Table 23: Credtworthiessand Requhred currenly has a limited capacity to borrow at c onaly (am miles) market interest rates and must establish itself as 2M a crediworthy country. Over the medium term, Tajksta's ability to obtain credi will Exports 734 depend upon amtining political stability, Debt 3615 sustined implmnation of strucral reform Dd tservic8 and strong export performance. Reaching an (100% on-1} 50 Deft Service Ratio early agreemet witth the IMF on a Systemic (IO% ns 115% Transfonnation Facility (STF) will also help Deg of cancessioalaw esmblish creditworthiness. Tajikistan's assets reahed o miaamta for mediu-m-m development include its well 20% debt serviace ratio 80% educted human resource base, agricltural and nanual. resources, and an irstu that canff. be repaired quidldy with reasonably small investents. The Governmfet's ability to deal with the cumrt unstable political and economic situation wi also significantly affect Tajikistan's creditworthiness. 2.31 Since Tajikistan's financing requimnents are substantial, one important question is whetr they should be based on concessional or non-concessional terms. Table 2.3 presents an analysis of these issues. If all extemal financing reqrmens are met through non-concessional borrowing, rapidly increasing debt and a high debt service ratio of 115 percen for the year 2000 would lead to a debt crisis. Alternatively, if there is a financing mix of concessional and non-concessional elements, the debt rado should not exceed 20 percent of market-based borrowing in order to keep debt servicing capacity manageable. The degree of concessionality in the financig requirements will be 80 percent in 2000. In order to help Tajildstan attain this concessionality, the World Bank bas identified it as an IDA eligible counry. Extnal Assstance Miana ent Unit 2.32 Tajikistan has no direct experience with foreign assistance and is unfamiliar with the terms and conditions of obtauiing such assistance and with the budgetay and appropriation procedures of various potnWial donors. The success of the exemrnal assistance programs depends on Tajildsta's ability to internally coordinate the requirements for various typos of assistance, matching these requirements with available resources and makming effective use of available aid funds through knowledge of the adminisative, fiancial and procume procedures of various aid agencies and donors. To overcome these difficulties, the Government has agreed to establish an Extemal Assistance Management Unit.  Economic Reforms and External Financing Requirements 25 EAMU will facilitate contacts between potential donors and various ministries, fiamiliai Government agencies with the sources of fumds and with donors' procedures and help match the available technical and financial assistance with the country's needs while ensuring that required domestic counterpart resources are made available. The unit will coordinate aid programs according to the Govermments economic priorities and policies and will advise the Goverment on the level and sources of foreign assistance and the allocation of this assistance across sectors of the economy. The World Bank has provided a grant under the Institutional Development Fund grant to assist Tajikistan in establishing this unit External Debt ManagemeLt 2.33 Establishing and maintining creditworthiness requires an effective debt management system. Such a system should enable policymakers to record, monitor and manage the country's existing debt and new extnal borrowing. In addition, Tajikisrans membership in the IMF and the World Bank rqires it to periodicaly report debts and debt servicing. The Govemment needs to creat a cental debt anagement office within NBT or the Ministry of Finance (MOFl In market economies ctenal debt is managed joindy by the Central Bank and the MOF. Tajikistan should adopt this approach and define the respective roles of the NBT and MOF in the debt management process as soon as possible The MOF should keep all records on central Goverment borrowing and closely monitor the level and terms of public and publicly guaraneed debt. The Central Bank should monitor and report the extemal debt and new borrowing by commercial banks and public and private enterprises. The NBT should also be responsible for managing the counrys foreign exchange reserves. This division of labor, while faciliing effective debt management, requirs close cooperaon between the NBT and MOF. The MOF would undertake eternal borrowing and related ransactons and ensure that funds for debt servicmg are budgeted. It would also prepare periodic reports on the debt siuation, including upcoming debt servicing needs. This information will need to be shared wih the NBT, which wil ensure that foreign xchage for debt sericing is availble. Since Tajisan has no experience in the area of debt management, technical and financial assistce will be needed to assist in establishing an effective debt management system. Major Risks to the Refonn Program 2.34 There are five key risks to the refonn progrm: (i) contined political instability; (ii) weak commitment to reform; (iii) limited implemention capacity; (iv) adverse external environment; and (v) unavailability of extemal financing. The fragile polidcal situadon poses the most uncertinty; contiumaion of the current fragile polical siation diminishes public confidence in the economy and impedes successf implemenion of reform measures. 2.35 Even if political stabilt is achieved, imple the reform program may result in a drop in real wages, generating dissatisfation among wage earners. Reductions in consumer subsidies and the need to exrcise financial discpline by enterprises may also increase opposition from managers who have benefited from soft loans and easy budgeting. Pressure from dissatisfied groups may delay or even derail the reform program. However, without reform, economic instbility will increase and the economic crisis will deepen. In this case, te costs of exorbitant inflation, ourd and inefficient enterprises, and unfulfilled financial and technical assistance requirmts will far exceed the costs of continig refonn.  26 Chapter 2 2-36 With political stability and gemnine Government commitment to reform, the authorities will still be confronted with the complex task of designing and implementing the reform program. TajikistTn currently lacks the institutional capacities and the skdll and experience required to design and carry out dhe reform program and move toward Lhe market economy. A technical assistance package will facilitate designing a reform program and enhance the Government's implementation capacity. The World Bank, in collaboration with the authorities, has identified a package of core technical assistnce needs covering a wide range of activities. 2.37 The external and exogenous enviromnent may also undermine the success of the reform program. The country suffers from civil strife and flood damage. Continuation of the civil war will imcrease secarity-relaed expenditures at the cost of essential consumption and ivestment Peace will ensure a conducive environment for implenenting the reform program and atracting foreign investment. Exogenous factors influencing the reform progrm include economic and political developments in the Russian Federation, with which Tajikistan maintains close ties. The country's decision to join the monetary union with Russia will make it very difficult for Tajikistan to guard itself against the risks of macroeconomic instbility in the Russian Federadon. Developments in the international market, especiay in the cotton and alumium markets, pose another exogenous rsk. To cushion the negative impact of developments in the intemational market, Tajikistan should consider policies that will diversify the composition and direction of its exports. The future of the alumium smelter is licely to impact both imports and exports. The closure of the plant could conceivably constitute a positive risk as net exports could increase. 2.38 Finally, lPck of adequate external financing could jeopardize the success of the reform progrm. Without external financing, Tajildstan mst cural investment and consuption, to the detriment of output recovery and public support for contiuing the reform program. Design and implementation of a comprehensive refum program will be critical to mobilizing the necessary extenal resources for reconstruction and to meet the country's tmchnical assistanc requements.  THE AGENDA FOR REFORM Adoption of a comprehensive economic reform program is essential to overcome the current economic crisis and facilitate movement toward a market economy. As will be discussed in Chapter 3, a number of priority meau shold be undertken in order to pomote private sector parucipation in the economy md initiate a programn for restructuring public enterprises. These measures include: (i) significant changes in the legal and institutional framework; Cii) rapid acceleration of privatization of small enterprises; (iii) establishing clear and realistic targets for privatization of medium and large enterprises; (Iv) strengtheing the instiutional capacities of the agencies responsible for inplementation of privafizafion; and (v) creating the enabling and conducive environmet necessary to attract foreign investment An efficient financial sector will play an important role in the success of the reform program. Chapter 4 provides an analysis of the following priorities: (i) assigning the role of mobilizing savings and channeing credit to the banking system; (ii) developing commercially oriented prudential guidelies and strengening the supervision- capacity of the NBT; (iii) aligning nominal interest rates with the Russian rates and considering furer increases; and (iv) improvig credit assessment, risk management skills, and commercial accounting systems. An efficient intemational trade system will provide a competitive environment and help to achieve a quicker moderation of the declining output and earlier reowery of the economy. Chapter 5 presents a description of the trade regime and discusses the importance of dimiishing the role of the Govermment in international trade and promotng industries with potential comparative advantges. A sound safety net system is essential if popular support for the reform program is to be mainted. Chapter 6 discusses why the past geermos social benefits can no longer contiue and targeting special assistance programs to the most vulnerable groups is a viable alternative. Modification of pensions, redrement age, paid maternity leave, and leave-without-pay periods are among the main topics of this chapter.  CHAPTER 3 ENTERPRISE REFORM AND PRIVATE SECTOR DEVELOPMENT 3.1 Tajildstan's difficult political and economic conditions, recent natral disasters, and delay in reforming the institutional and legal framework all impede the growth of the private sector and retard foreign investment. To support Tajildstan's transition to a market oriented economy, a strong private sector must be developed rapidly. Private initiatives are constrained by political and economic instability. legal and regulatory inconsistencies, the absence of adequate support institutions, and severe constraints on foreign trade. Underdeveloped financial markets and institutions that do not provide financing on a commercial basis also hamper private sector development. In addition, inflation has eroded the value of domestic savings, so that capital to finance both privatization and private sector development is limited. 3.2 Although privatization began in 1991, the Government is still in the process of establishing the legal and institutional basis for developing of the private sector. TajikistanWs entepreneial sklds, trading tradition, and natural resources provide the basic ingredients needed by a private sector. This chapter discusses the legal framework that would support a market-onented economy and an emerging private sector. It then reviews the privatzation program and analyzes the various issues related to strategy. methods, and instimtional framework. It also identifies the obstacles to privaizaion and addresses governance and resructm ng issues. The final section assesses impediments to developing the private sector and foreign investment. Each section concludes with a set of recomnons. The Legal Framework to Support a Market Economy and Private Sector Development 3.3 Tajikistanhas enacted several laws aimed atdeveloping amarket economy. Several laws deal with privatization and private sector development: Leasing (1990); Registration of Enterprises (1991); Privatizaion of StatOwned Enterprises (1992); Joint Stock Companies (1992); Foreign Invesunent (1992); Enteurship (1992); Bankruptcy (1992); and Enterprises (1993). These laws address specific acdvities and areas, but do not yet provide an overall famework for developing a market-oriented economy. Ther are significmt gaps in such areas as property rights, contract law, and secured tamnsacons and collateral. Other deficient areas include the recording and transfer of property, intellectual property Ights, and protection against unfair tade pracdtes (false adverdsing, faud, collusion, etc.). In additior to a clear legal framework, the private sector needs confidence in the enforceability of agreements, transpaency in dispute resolution, and recourse against arbitary administraive acts. The judicial and disputes settlement system must be mproved if thy are to effectively bandle the complex disputes that are likely to emerge. The current legal framework does not reflect a coherent legislative stategy and displays an increasing dichotomy between enactment and implementation. The lack of coherence is further underscored by the fact ta Tajikistan has yet to adopt a modern post-Soviet era constituon. Although several amendments relating to the economic system were introduced, notably to Chapter 2 of the Constituton, the extent to which private property is recognized remains obscure. Summary of New Laws 3.4 The Property Law, enacted in 1990 divides property into three categories: (a) state property, (b) collective property, such as labor collectives, cooperatives. joint stock companies, leased  30 Chapter 3 property, and other economic associations; and (c) "property of the cifizen", such as individual economic activity and small enterprises engaged in production of consumer goods and trade. This tripartite arrangement has its origin in fte administrative-ommand economy; in market economies, the only distinction is between state and private property, with collective property a subset of private property relationships. Draft amendments to the Property Law recently introduced in the Supreme Soviet do not substantially change these types of property. Citizen's property is now teamed as "private property", and its definition is expanded to include other types of producton such as shares. Moreover, in the draft amendmonts, there are stili a nunber of open issues relating to property rights, including the absence of transparent and enforceable systems of creditors' rghts and debt coilection; potential liabilities attachng to property, such as enviromental risks and costs; and inadequate clarification and protection of ownership nghts associated with inteliectual property and technology. Box 3.1: Legal Framework in a Market Economy The legal fmeworkl m a market economy has ata mmimum four basic economic functions. Thse are to: (a) defime the 'universe of property rights in the systemr. I) establish a framwork for exhanging chs rights. (c) set rules for acorsentering and exitingproductiveactivuiies; and (d) overseemarkctstrmurandbehavioroprmtEompetition These four basic tasks of a legal system relate to specific and well-recognized areas of law.. Pmqpery rightr are usually defmied in the country's cntitio and more speific lkas deal with ra tangible, and intellectual property. Exchange is generaly govened by contat la wnryis goverd by company and' foreign investmentlaw. while bankruptcy and liquidation laws govem exit. Fnlly. antonopoy ad u nY. laws are intnded to promote competition. These basic arms of law are augmented-by laws addrg many-other nportunt activides such as labor. taxation. and banking. The resuliing complex environment co s the legal frmework for privat sector activity in advanced market economies. Souce: Cheryl W. Gray and Associats. Evolving Legl Frameworks for Private Sector Development in Central aiid - Eastern Eope. 1993. The World Bank, 1993. 3.5 The Law on State Ownership and Privatizauion, adopted February 21, 1991, defines privatization as an activity of the state which twansfers its ownership rights to collective gmups and citizens of Tajikistan. The law authorizes transfer property rights to foreigners, including citizens of other FSU republics. Transformation of state owned properties inthe privatizationprocess include: lease, lease with option to buy, sale of shares, sale by instllment to labor groups and otflers, purchase of state entity by workers, and free transfer of state property. Discounts, favorable terms, and priority are given to labor collectives. The draft amendments to the privatzation law introduce novel and desirble elements such as: and public participation, social protection of all citizens, equality of citizen' rights to obtain a share of property, use of privatization vouchers and savirg amount schemes, intuction of a mass privatization program, and better control over the privatization process. The State Property Committee (SPC) is requested to submit a privatization program for the approval by the Council of Ministers. Although the draft amendments add valuable concepts to the privatization law, they do not change essentially the process or guarantee the independence of privadzed property. 3.6 The Joint Srock Company Law defines three types of joint stock companies that can operate in Tajikistan open joint stock, closed joint stock, and limited liability companies. Each must have at least two shareholders. The SPC and the labor collectives of the enteprise that is being  Enterprise Reform and Private Sector Development 31 transformed are usually the main shareholders. According to the law, dhese companies are independent and fee to detmine their own form of management, marketing, wages, and profit distnbution. They have a board of directors, and can issue preferred and common stock and bonds. They also can pay dividends, keep reserves, and give stock options to staff. Despite this corporate form, which is similar to that found in free market economies, corporate independence is rather illusory. 3.7 TheLaw on Leases sets the conditions for an enterprise lease with an option to purchase. The period of lease is determined in accordance with agrement. Purchase price is based on the cost of the property at the time of lease. Purchase occurs when a cash payment is made after the lease has expired. Labor groups have priority, but any citizen or group can lease enterprises by forming a leaseholders organimzation that can issue securties. Leased enterprses have mnmerous operating restrictions. They continue to receive budgetary support and subsidies, but are held responsible for the social and economic development of the local territory. They must carry out state orders and set prices as specified for state enterprises. They are essentially state enterprises, owned by a labor group and carying out state-sanctioned activities. 3.8 The draft Antmnopoly Law, based on Russian legislation, recognizes that increased competition is necessary to improve the efficiency of stat-owned enterprise (SOEs). The law forbids certai monopolistic activities, oulines sanctions and penaldes. and designates a specific office in the Ministry of Economy to monitor the behavior and price setting policies of monopolies. 3.9 The Law on Entreprewship regulats the economic activities of ciizens and individual "juridical persons'. It emphasizes equalty of different types of property and feedom to engage in any economic actvity. However, the state also claims a large role in entrepreneurial activities by atrcting conditions and opeaing restrictions to the transfer of state assets. It also closely regulates these activities through registration and licensing requirements. Although it is a step in the tight direction, the law on Entrepreneuri still contains too many of these restictions. 3.10 The recently enacted Law on Enteprises sbeds many of the archaic concepts about property. Enterprises can engage in any type of domestic business activity and can independently engage inforeimgneconomic acevitis, buyforeigacurren.y, and obtanforeigncredits. Government interference in the economic, finacial, and other opeational activities of enteprises is prohibited, and price seting is an exception rather than the rule. This law is a significant step toward liberalization of rules that govern enterprise activities. 3.11 he Law on Peasant Households establishes the legal rights of firmer households tO carry out economic activities, eithr individually or in associaion with other enterprises, and receive a land plot, which is granted for life and can be inherited. The household is given the rights to personal plots adjoining the house. Plots may also be allocated from the land reserve or other agricultural lands not now in use. Reconumendations 3.12 Completing the legal framework necessary to move to a market oriented economy should be a priority. Areas that need special attetion during 1994-95 include:  32 Chapter 3 a. Adopting a modern constiuon that guarantees the right of natural and jundical persons to own and exchange property, protects private property, and provides for an independent judiciary and for juridical review of legislative acts. b. Enacting modm civil and commercial (mcluding company) codes that provide a well-defined framework for entry and exit and market activities, exchanging property rights, operat business activities and overeing the stucture and behavior of such activities. c. Implementing mechanisms to register property rights. d. Revising the 1991 law of state ownership and privadation of property and related implemention decrees. e. Establishing and developing insituons critical for the success of legal reform and the proper application of the ne-w laws, including privatization agencies, company registration offices, anti-monopoly agencies, baning regulation offices, land offices, legal departments in ministries and other government offices. This requires an overall review of administrative reform measures and training officials in legal and regulatory aspects of economic reform, It will also involve strengthenin the judicial system's ability to enforce the economic laws and contractuat obligations essential to protect property rights. Mrivatization Privaton, Enterprie Reform, and Corporatization 3.13 Early in the refoM. Table 3.1: Industry Structure,1992 process the Government designed a program fo conunercilization ~Subseaior No. of Output Employ- program for commercialzation andEmpie h rl) ea privatizacon of state enterprises. hnplementation began in mid-1991, but Enery 6 234 3,049 economic and political instability Elecmricir 28 4.859 7,354 interrupted thie process. The new Memillurgy 10 19.301 13.87 Governmen. appointed in November Fefous 1 30 118 1992, decided to activate the stalled Machnr Bulding 398 19,271 377190 reform in the face of the rapidly Chemical 13 3,392 10.955 deterioratig econo situation. Building Marial 210 1,901 11.351 Wood & Paper 189 767 5,598 Strucure of Industry Light 130 27,692 69.872 Texte 53 25,543 45.342 Food 267 9.487 23,922 3.14 In the late 1980's, the Others 314 - - industrial sector comprised about 30 TOTAL 1.628 98,421 228,505 percent of GDP. By 1992. as a result of the civil war, several natural disasters, Source: GoskonS.aL and disniptions il interrepublican trade, industrial out had fallen to less thzan 50 percent of 1990 levels. The most important industries are  Enterprise Reform and Prvate Sector Development 33 mining (ores, gold, silver, and coal) aluminm processing, and the textiles. The number of indusal enterprises is somewhat uncertain because some were destroyed during the civil war or are inactive, due to shortages of fuel or spare parts. In the agricultural, trade, industrial, and transport sectors, there are about 2000 state-owned enterprises, all classified as republican property. In the industry sector alone, there are 1304 medium and large enterprises (Table 3.1). At the municipal level, there are about 5,000 enties with less dan 50 employees. These are segmented units of small state enterprises, mosdy shops, service establishments, and trade units. In sum, there are over 7,000 state enterprises/entities of all sizes. Scope and Progress of the Privatization Program 3.15 Although the Government regards private enterprise development as a key element of the economic reform program, the current privatization program is too narrowly defined. It focuses on small and medium enterprises, and to some extent, on larger enterprises that are non-profitable or heavily subsidized. The 1991192 privatzarion program, approved in October 1991, targeted the sale of 1Z76 enterprises, of all sizes and from different sectors of the economy. The 1993-1995 privatizaton program proposed to add medium and large enterprises to the list. Thus, by the end of 1995, the objecdve is to privatize over 19 percet of all enterprises. This represents only 6 percent of the 1304 the medium and large enterprises (Table 3.2). 3.16 Household plots can only be leased from collectives and stae farms. Table32 MediumandLareRepublianFeprbestobe Privaizaton of houses, and aparments is P t i99S proceeding on the basis of a special order of se= 1993 1994 1995 the Council of Ministers, since a draft law on privatization of housing has not been Inusry 26 7 2 adopted. The district (rayon) executive Constuio 5 3 council is in charge of privatization of TasPrtion 2 - housing. As of October 1993, over 50 Trade 9 percent of all dwellings were priatized; the AgiP l 14 1 average nominal price chrged to insiders was O,ers 7 l 12,000 rubles. The Chairman of the Supreme TOTAL 65 12 2 Counci signed an order to provide free apartments to social sector employees (doctors Snc: Se P Co . and teachers) and invalids. 3.17 As of October 1993, 846 enterprises of all sizes (excluding housing) were privadzed. More than 600 of these were small-scale enterprses with less than 50 employees, while 152 were medium and large enterprises in the agicultural, industdal, tasport, trade, and building sectors (Table 3.3). Box 3.2 sumarizes the privatization of small, medium, and large enterprises. bnstitutional Framework for Privatdztion 3.18 Privatzation policy is carried out at two levels: the SPC and its regional representaives for republican prper and the Municipal Execive Committee for mumicipal propery. SPC, which is part of the executive branch, has oblast-level commiltte for the Leninabad and Khatlon oblasts and th Gomo Badakhan Autonomous Region; a conmm for the city of Dushanbe, and eight district offices in regions diectly administered by the central Goverment. The SPC is responsible for the privaintion and copora on of medi and large enteprises. In practice, supervision of large enterprises is still  34 Chapter 3 Box 3.2: Privatiation Accomplihments Regional and district communities are moving ahead with smal scale priwzadoan mostly trough negotiations with labor collectives. As of October 1993, only 12 percent (600) of small enterprises had been priatized. They included enterprss in industy, transport. trade, construction. services. and sales:kiosks. Marrket orierned methods of privatization have not been used often enough. Sixty percent of the privatization agreemen have been concluded wilh labor coflectives, often in non-competive tenders. which has limited the scope of outsider paricipation. As part of the small scalc pratization program, 35 unfinisued buildings were also offered for sale but only one was sold. A change in the Tegulations and procedures and a list of additional enerprises are being prepared to give more chances tO outsiders and emphasizing auctions as a method of sale. Medium and hlre pruadon is moving slowly. Only 12 pcnt of entepises (50) in the industrial, agricdlure. transport, servicts. trade. mining and building sectors havc been privatized.Only:6Centerprises were sold to private companies, whilc over half of the entrprs have been sold to collectives (witL most shares often retained by the director general). Privatized eanerprises are bound to see no change in mangemt and depend on previously established netwoks of suppliers and distributors; under the relevant niinisties and bodies. Under existing law, the SPC responds to collective initiatives, and does not control the privatization timetable. As a result, the privatization program is proceeding slower than planned. 3.19 In tenns of inernal organization, the SPC has seven policy departments, one internal adminisration department, and a related Center for Valuation of State Property. The seven deparmet are: the Joint Stock Companies and Investment Funds Deparument, which prepares regulations in these areas; the Privatzation Department, which works with local organizations at the municipal level, prepares privatizaton programs. and supervises implementation; the Valuation and Privatizaon Plas Department which provides expert advice and drafts correspondence and contracts; the Admistration of State Property Department, which supervises the state portfblio; and the Methodology and Statistcal Information Department. which provides advice on processes and procedures of privatization, and compiles statistical data on enterprises. In addition, there are legal and accounting departments. The Center for Valuation of State Property is a self-financing autonomous body charged with valuation of SOEs. 3.20 The SPC has 70 personnel slots at the central office, of which about 50 are filed. Personnel shortage is more evident at the regional and district level. Duties are often delegated to the disrict executive committees which are not always imerested in carrying out the additional tasks. Curremn Prvatiztom Stategy 3.21 According to the June 1993 draft of the Government's program of economic transformation. the objectives of the privadzation policy are: to eliminate state subsidies to enterprises; to develop small and medium businesses; and increase efficiency and competition. There seems to be some confusion about the ultimate goals of pnvatization and establishing private property. The most important goal of privatization is to reallocate resources to their most productive use. Transferring ownership of state assets and permitting the free flow of capital and labor will conbute to this goal. The objective of maximizing the sale proceeds of pnvatization should be secondary to the main objective.  Enterprise Refom and Private Sector Development 35 Tabl 33: Medium md lrge prihadtkon necomplhbmmut, - of October 1993 Sector Private Employee Lased Jhint Stock Bought Tobl Company Colective Company Real Edtate Agriculture 15 1 16 Industy it 3 13 27 Construction & Materials 2 16 5 11 34 Transport 3 3 2 8 Trade, Reuil 3 15 2 3 1 24 Catering 1 3 4 Services 1 14 5 7 2 29 Mining Metallurgy 5 1 1 7 Other I 1 1 3 Total 6 R1 22 38 5 152 a/ List of joint stock companies were 40% of shares were sold to labor collectives. Source: Ste Property CouIitteC. 3.22 As stated in the draft rogram of economic reform, as well as in the decree on Privatization dated April 18, 1991, the Government's objective is not to undertake a rapid privatizaion program, but to promote legal and economic equality in the forms of owmership. This is a very narrow concept of privatization ta aims only at freeing the state from the obligation of providing financial support to unprofitable enterprises. This can be seen in the way the Government has categorized all Republic'.n properties or SOEs for purposcs of privatization: a. SOEs that will not be privadzed becuse they are of strategic imporne, such as minerals, electi;c power lines, gas pipelines, trantation links, telecommunications, land, banks, health facilities, scbools, mil , etc. b. SOEs that will not be privatized during the initial stage of reform because of their role in the national economy, such as the largest industrial enterprises, railways, aviation companies, etc. c. SOEs that will be privatized tirough auctions but with management and control remaining with the state. d. SOE which are low profit or bankrupt enterprises that will be privatized through auctions with a transfer of control to new owners. e. SOEs that will be privatized through a direct transfer to private ownership on a compensatory and non-co xmpsaory basis. 3.23 The current privatization strategy is restrictive and lacks an overall systematic approach. The decision process is cumbersome (Box 3.3), and the phasing-in of the program has not been well designed. There is a need to develop more innovative methods, to move rapidly into the accelerated  36 Chapter 3 phase of privatizing of medium and large enterprises, and to immediately intensify privatization of small scale enterprises (Box 3.4). Box 3.3: Privatization Decision 1m The current decision making process for privatatitaon is cumbersome and takes place as follows: 1. Transform selected numbers of medium and largc enterprises into joint Stock companies that can be sold later. 2. Encourage and build on employee initiatives; offer to sell small scale enterprise to the employees; if they are not willing to buy, tie enterprise is then aucdoned (which has never happened so far). 3. For medium and large entrprises, the labor collectives first decide whether or not they would like to be privatized; the SPC jointly with the employees, examine different privadzation options. 4. In rare cases, the SPC takes the lead in selecting enterprises for privatizadon. This happens mainly with non-profitable enterprises or those on the verge of bankruptcy. Mehods of Privatization 3.24 The 1991 privatization law specifies several methods of privatization: * leasing enterprises and other state property; * leasing enterprises and other state property with the right of subsequent buyout; * auctioning state enterprise property; * sale, including on an installment basis, of enterprises, production facilities, and other state property to labor collectives, other legal entities, and citizens; * gradual buyout of state enterprise property by its labor collectives; * sale of integral property, which may be carried out through public trading, competitive bidding or auction; and * transfer of state property without compensation. 3.25 In Tajikistan, the main method of privatization used, so far, has been sale to labor collectives, which have the right of first refisal in the privatization process. This method has allowed the privatization program to start quickly. Often, the privatization of an enterprise goes through various forms of privatization in succession. First, the labor collcctive leases the enterprise. Accumulated profit is then used by the employees as a downpayment for the purchase of a portion of the shares (up to 40 percent) in the joint stock company. At the end of the process, the labor collective buys 100 percent of the shares. Some employees are lost at each stage, while the remaining ones accumulate more shares. This leads to large inequalities in the ownership interests of managers and workers, and old and new employees.  Enterprise Refonn and Private Sector Development 37 Box 3A: SmalkSae Privatizaiou Expience in Eser and Central Europe- Privatization of smallscale enterprises in Central and Eastern Europe is widely acknowledged to have bee:n successfihl. The sale or uamfer of ownership andlor leasehold rights bas occurred quickly, and has-notbeen-intensively- opposed, either by fonner employees or the overall population- Small-scale privatization has led to a substantial improvement in the quality and quantity of goods. services, and jobs. -- Small-scale enterprises have been th first entites to be pivatized in di .1rmnerly socialicountrie of C and Easen Europe. These commercial enterprises usually involve retail trade, public catering, and conmer services. While some Cenatmad Eastern European counries have adopdspecial and laws govering tpiviz.t-.-: of small-scale enterprises, in most, the transfer of ownership has been decentralized and left to tedi of rgiWnal,: municipal. and local officlals using a variety of techniques..including admasiguave measurcsm. rtransactio _sand:-- a wide range of intennediate options. One key element of-market-oriented approaches to- Is e been the liqwation of sate entrprises befiore privaion. which has creased conditio for a more effi K permitting greater resources and efficient use and transfer of assets of the privaid en of dhe aCminisraive approach to privatization bas involved.negotiatng comtratsi insid (elsn manageminot). excluding other interested parties from competing for the p ty. In diate pt. tender invitations made exclusively to insiders, and open auctions that offer pre tial reatmeD inidOb the most market-oriented approach has involved selliingsmallsca terprises open auconaeowne r leasehold rihs go to the highestbidder.. In some coutries of ECenlad bEasmeEu noaec aSv Republics, all bidders in open auctons participate on an equal footing,ad insidersrist. However, in some cases, new. owners are obligated to-maintain existing employmaet lkeelsvadbuinep ctin period of time Irespective of the mode of tansfer, privazation in CentraldEaster Euwp e' allw bod (i) Sale, lease, or transfer of existing P as -c h d; obligations to employees; and (ii) Liquidation ofexisting nerprses. with subsequent sale or tansfer of only their assets (freholds or .- leaseholds, as well as equipment and inventory). --'5; 3.26 In many cases, the labor collecdves have been able to turn around the company in a very short period of time (Box 3.5). However, the cumbesome and non-competitive aspects of this method have several drawbacks, especally when applied to medium and large si enterpnses. Fist, the method will not allow privatization to accelerate. Second, it does not lead to effective corporate goverance and socially just distribution of ownership. 3.27 The privatization process in Tajildstan could be described as "bottom-up", since the proposals and decision to privatize come from labor collectives and managers. On the other hand, once the decision is made, a quasi "top down" approach is followed by the SPC in impleming the tansaction. The two approaches are not well balanced (Box 3.6).  38 Chapter 3 Box 3.5: Azi clothing store, Dushanbe: A Success Story The case of AZIZ. a dottng store in Dushanbe, is a good example of sucsu piation and how it has effected the saes operation. Prior to privatization. the shop was sae-owned and subordinated to the industrial amalgamatioa. In 1990. die labor coDective leased die shop from the city. prepared a business plan, opened a bank account, and began to accumulate profiL In August 1991, the labor colective applii for privat'zation. submitPing to the city and to de SPC a set of documents and a program of privatizaion. In September 1991, a formal offer for purchase was submitied. The Stm Property Commitee and the City Commission examined the application and agreed on the sale price suggested by the SPC. A contract was signed between the City Executive Commitee and the labor collective. Twenty percent of the price was paid as a down-pymen, while the remainder was to be paid by insallments in five years. AU payments. howcver, were paid off in one year. Before privatizion, 20 persons were employed, there was no possibility to increase production and the average turnover was 250,000 rubles, which alowed the sbop to fulfill the fied state targeL The shop was sold to the laborcoOective at the end of 1991. In 1992-1993 the laborcollective opened two other brnch stores in Dushanbe and started a sewing operaon doubling the number of emplyees. k also opened a subsidiary in another town, with bodh a shop and a warhouse. Production was diversified and increased threefold; salaries also increased. Since privatian, the company has reinvested 2 m llion rubles from the afher tax profits. The price of the clothes they sell is now lower than those in stae owned shops. New employees can become parmers after a three year trizl period. The company's future plans include opening other subsidiaries in Tajikistan and in neighboring republics. The company also wants to diversify its line of products by offering foodstuffs. Corporatization 3.28 Corporatizadon is progressing and 38 entprises from all sectors have been tansformed into joint stock companies. The basic criteria for corporatization is for the company to have over S0 niillion rubles book value. The transformation is undertaken on a case by case basis, and is done at the enterprise level with the assistance of the SPC. In the case of a group of 25 industi companies that were transformed into joint stock companies, the Govermnent turned 40 percent of the shares over to the labor collectives, retained 40 percent for the state, and reserved 20 percent for later sale to private investors. In other cases, often more than 40 percent is sold to the labor collectives and 20 percent of the price is required as a downpayment, with the remainder to be paid off within a few years. Post-Privatization Conditions 3-29 Notwithstanding the possible detrimental efflcts on the newly privatized firms, many of the post-privtization restrictions stem from Government interest in regulating economic activities. Five main post-privatization conditions usually are incorporated in the sale contract. For a period of three years, the new owner is required to: (i) keep the same type of business profile; (ii) increase the volume of production and not reduce the output to a level lower than before privatization; (iii) fulfill all comnitments and contracts signed by the previous owner; (iv) attempt to find jobs for laid off employees for six months after the layoff, with this obligation ending after six months only if the owner can prove that he followed all of the requirements of the labor laws and still failed to find jobs; and (v) not resell or transfer the entity before the final payment is made. Use of Privatization Proceeds 3.30 The revenues from the privatization of republican property are transferred into a special account and their use is decided by the Supreme Soviet. So far, privatization proceeds have been totally  Enterprise Reform and Private Sector Development 39 Box 3.6: Bottom-up/Top-dowvi Approach The privaization progams dth-have -been developed across the Fonrer Soviet Unioni (FSU) Republ incorporate all tbe adidonal methods of privatizaion. The principal privatization approach toe.merge:so far inmast of:- the FSU counties relies on a balanced use of 'top down and 'botom up4M ' approaches.-- In general. most Republics have adopted a pd setting rules and anapproval.- prcess, while adopting a 'bottom up' appmach *hat allows the enterprises thmsdlvs to put together thi privatization - plans and implment the trascti. With regard to medium and lag scale e pi, Russia has -optedfor the 'bottomup' approach forenterprise-pmposals whil the centlauthoritybas settrulks of the gpzne adiom the top down. In smal scale privation. both rules and program initiatives have largely been delegaed toelocal auhorities,- leaving dte entprises and central authorities with a notably passivetrole. Exceptions to this balanceof 'top down' and 'botom up' approaches have occurred in Kazakst. where a -top doW .-approach seems to have;-prevailed. -In Lidnia, dhe '"p down' approach appears to have ben suessidin promong rapid. impl icssof privatization. As for larger nuepries. the 'top-down" approach so farhs been limied to a f irwhere.either hard curcy eanuigs or early success have been sought. jlightof th r ve siw cievei . privatization relying on inatives firm outside buyeis -some FSURepublics -. .arecousidegmos iitiatives in the future; It is clar that, regardsi of theapproach,l ther l isa neo.ed Irtransparent.ruesand. governing the process. In countrieswhere amass sagyh2 sbeenmplenteedbis comenp&ete entprses, a combinatin of 'op-down