Turkmenistan - Institution Building - Technical Assistance Project

Docutent of The World Bank FOR OMCLAL USE ONLY Be" No. P-6335-TI NOERANUM AND RECOMMENATION OF. THE PRISIDENT OF TOE INTERNATIONAL BAINK FOR RECONSTRUCTION ND DEVELOPMENT TO THE EKECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$25 MILLION TO TUR13EIMSTAN FOR A INlSTITTION BUILDINGITECMTICAL ASSISTANCE PROJECT AUGUST 25, 1994 MI CROGRAPHICS Tbis document has a resrictd distbuton and may I their official duties. Its contents may not otherwise Report No: P- 6335 TM Type: MOP  TURKMENISTAN INSTITUUTION BUILDING/TECHNICAL ASSISTANCE PROJECT CURRENCY EQUIVALENTS Currency unit = manat US$1 = 10 manatsL Exchange Rates November 1993 2 manats August 1994 10 manats WEIGHTS AND MEASURES Metric System GOVERNMENT FISCAL YEAR January 1- December 31 Ink May 1994, a new commercial rate of 60 manats to the U.S. dollar was introduced, which was changed to 75 manats to te U.S. dollar on August 15, 1994.  FOR OFMICIAL USE ONLY TURKMENSAN INSIITUTION BULDING/TECNCAL ASSISTANCE PROJECT ABBREVIATIONS CBT Cntral Bank of Turltn CEM Country c Memoram EBRD Ewopean Bank for Recostruction and Developme FSU Former Soviet Union GDP Grs Domesti Product GNP Gross Nationa Product EBRD Ienadonal Bank for Reconstuction antd Development ICE Innationdl Competitive Bddi8g IFC Iational Finance Cotporation IMP Inatdon Monetary Fund LRU Legal Rdeom Unit MIGA Multiler vestmet Guartee Agenc MOEF Mistry of Economy and Finance MOo Mistry of Oi and Gas NBF Non-Ban* Funding NM? Not Material Prodxct PIU Project Implmentation Unit PPF Project Preparadon Facilit SOE State Owned E prises VAT Value Added Tax USAID United Saes Agey for Intenadonal Devopment IThie docume nticed dsbutioan ad my be usd by reciit ol in the PeI*w'uib@fr j dud. ksconawmay nototuWi be disclsd WietW ord an authol  TURXMENIUSrAN TITUmTJON BUIELDINGITEC NICL ASSISTANCE PROJECT Loan and Pect Summry Borrower: Turkmenistan Benefidary: The Goverme of Turkmenistan Amount: US$25 million equivalent Tenus: 20 years, inchlding 5 years of grace period, at the Bank's standard variable hiterest rate. Descriptlon: The proposed Loan would finance technical assitane and eqipment needs for the following components: (i) privatization and private sector development; (ii) financial sector modernizaion; (iii) soqial sector; (iv) energy sector; and, (v) institutional support and development. In addition, this Loan would finance the establishment of a Project Implementation Unit (PMU) to support the implemention of this Loan. -lacn PIM- Foreign as L'oca Foreign Total % of Total --US$ million equivalent IBRD 1.6 23.4 25.0 94 oovemment 1 1.0 = Total Base Cost Q- Ftimated IBRD Disur e: FY95 FY96 FY97 FY98 US$ million equivalent - Anmual 5 7 7 6 Cumulaive 5 12 19 25 Ecnomic Rate of Retuh: Not applicable. Poverty Category: Not applicable. Staff Apprabal Report:, Report No. 12959-TM Map:N IBRD) No. 25096R1  MEMORANDUM AND RECOMMENDATION OF THE RIDENT OF THE INTEATIONAL BANK FOR RECONSTRUCTION AND DEVELOlPNT TO THE EXECUr VT DItECTORS ON A P1ROPOSE INTI UILDING/12CHN1CAL ASSIANCE PROJECT TO TURIMENIAN L INRODUCION 1. I submit for your approval the folowitg memoradum and on a proposed Institutional BOdngTeh,ical Asisae Lou (the Loan) to kac the eqiaen of US$25 million to support the Government of Tur stns overa refom program. TUe Loua would be ate X Bans stadad vaal est rao, WIt a maur of 20 Yeas, Icudn 5 years of gra 2. bm jomid the World Bank and theo IF on Sep_eb :22, 1992. A Country EconDmic Memodum (CEM) was isued on May 31, 1994 and an nrg sector report b beiqg pIrpared. hi pwposed project woud constte th fis Bank opaeaon in stan. IL COUNTRY POLIUCS AND BANK GROUP ACTIVTIES A. C es and Recent Perforinatce 3. Ba nd. Tu nist a landlockd Central Asian country with a populatn Of about 3.8 millon people - th fourth smalUest of the fom Soviet Union (U) ountries. In tae of ar, b the frth largest of the PSU republics (500,000 km). However, the Ki& Kum desert covers 90 percent of the tot land area. Tr nlsmta per capita income was estmated at US$1,270 in 1993. 4. he economy of Turkmenist is dominated by agdc and energy. Agricuu yields are low by ntrnational standards becaus of years of Inefficient water use, sdal o, rigato of In iland, and overdevelopment of coton cuvion. ois specializaton in cotton has made the economy heavily dependent on food hIports. S. T I is well endowed with eney resources, primarily natual gas and oil. t is thse scond laget natural gas product In the FSU aftr the Rusian Fedeaton and the fourth largest in he wod. k is al the fourth lag ol producer In the rgion. Ikt i rich in mineral resources, and has large tesources of Wne bm e, sodium suipht, various silts, and dutr ar indications of d and pltnum. Despite di naupral wealt, Is one of the least devloped rpblic, with the hiest Ia mority and the lowet life expenc. 6. Natura factors are a mejor costra to Ts developmet. Water Ii scarce, and the country is remote from markets. The ndustri sucture b a result not only of this resource base, but also of the former Soviet Gosplan, with ts heavy emphasis on lae plants desiged o service the whole of the former Soviet Union make also largely directd ward RussL  -2- 7. Turkmenistan formally declared its Independece from the USSR on October 27, 1991. A new constition was adopted by refeendum on May 8, 19, folowed by presidetial olections in which President Niyazov was reelected. Enjoying strong executive powers, he is assisted by an appointed Presidenal Council. After indepnc, the Commnt Pahrty was formaly disbanded, and many of its former members joind the Democraic faction in the Supreme Soviet. B. Recen Economdc Deveopment. 8. Turknenistan has been relatively less adversely affected by the breakdown of the Soviet Union tanother republics. The decine in GDP is estimated at about S percent in 1992 and 9 percent in 1993. The relatively lower drop in Turlnn's output and income is partly due to sipgificant new Govement constrction activity undeake In 1992 and 1993 and Improved terms of trade as a consequence of large increases in the prices of its gas exports to the FSU nmrket. Turknmenistan has been slow in institting reforms in support of macroeconomic stability. Turkmenistn was also slower than other FSU countries in implementng strucua reforms, especially the removal of state orders and subsidies, and privatization. While cont': i controls helped temporrily in preventng drastic declines in Tu ltn's economy, they slso disguised the need for fbndamental ausutent. 9. 's hard-cuency and rade accounts were in surplus in 1992 and 1993. Exports were largely domiated by gas, oil and cott However, the balance of paymen oudook for 1994 is unclear since Turkmenistan's energy exports are hampered by two problems. Turkmenlstan is dependent on the Russian gas pipeline for hard-curency sales to Europe. Russia pools its own gas vith that of TurmnlDdstan an then uses it either domestically or for hard- currency exports to Buropt. In early 1994, the situation has been complicated by Russia's firter limng Turkmenistan access to the pipdine for hard currcy expot, ts constaning its foreig excne eings. 10. Furthermore, developmen on the extera sector have condiued to be dominated by the accumulation of arears on the part of Turkmenistan's trading parners, notably Ukraie and Georgia, for natural gas imports, and the substatl reduedon in gas shimes. In the first quarter of 1994, Net Materid Product (NMP) fell by 18 percent over the coems ing period of 1993 due to the sharp drop in gas exports. By May 1994, the arrears had readced US$2 billion. As a result of these developments, the current account in 1994 will probably show a sizable surplus on an accrual basis, but on a cash basis, the curent account is expected to shift to a deficit. 11. The Government introduced its own currency - the man - on November 1,1993. Between November 1 and November S the official exchange rate was set at US$I - man 2. The exchange rate has been artficially constained since foreig exchange aucdom w suspended in early December 1993. The Central Bank devalued the official ehoage rate to 10 manats to the U.S. dollar in March 1994. In May 1994, the Central Bank introduced a new commercial rate of 60 manats to the U.S. dollar, which was changed to 75mnmats to the U.S. dollar on August 15, 1994. 12. Developments of prices in 1992 and 1993 were basically ifluenced by the Impued tion from the ruble zone and the persistence of price controls for about forty consumer goods and  -3- services. The rate of change in consumer prices was 17 percent in February 1994 and inwreased to 36 percent in March, and 26 pecent in April 1994. 13. Turkmenistan's foreign exchange eanings, which constiute a substantil share of total Government revenues, are chaneled through an extra-budgetary fumd. When the hard curmncy revenues are taken into account, the budget showed a surplus of 14 percent of GDP in 1992. The siuation began to deteriorate in 1993, as a result of accumulating arrears of some FSU countries on Turkmenistan's energy exports-70 percent of total government revenues consisted of hard currency receipta from the gas exports. The budgetary oudook for 1994 will be extremely semitive to: (i) the payment arreams for FSU gas exports; (ii) excha4ge rate policies; (iii) prospects for price reform and the level of transfers and subsidies. m. POLICY PRIOPITIES DURING THE TRANSITION A. Stabiliztion Program 14. Macroeconomic stabilization would depend on sound fiscal, monetary and exchange rate policy but would also be constraied by he growing afrears on gas exports. Turkmnenistan's budget deficit is increasing due to lower revenues from the energy sector and inadequate fiscal policy. To keep the deficit under control and support a reasonable level of public investment, the Govermment would need to widen the tax base through such meues as reinstating the gasoline tax, reducing the exemptions from the VAT and income and profits taxes, incrmasing user charges, and adjusting housing rents. Further, since a high proportion of revenue comes from energy, the Govemment should review the sector's taxation and pricing system. 15. The Govermnt is still operating several off-budget funds and several subsidies and capital lending do not appear in the Govemment's budget. To improve the tansparency of the budget ail extrabudgetay funds, including the hard curncy fund, subsidies and outlays for capital lending need to be included in the budget. 16. The focus of monetay policy shruld be to reduce inflation. Currently, however, the Central Bank has litfle influence on montay policy sine fiscal shortfalls are automatically financed through a governent overdraft faclt. Tb; overdraf-t facility should be closed. Furthermore, enterprises are being provided with D e entialu access to subsidized credit. Turkmenistan needs to move away from the central allkAtion of credit. Any inplicit subsidies for credit durng the transiton period should be made tasparent through the budget process and be strictly limited and eventually phased out. 17. The success of a stabilization program also depends on the exchange rate arrangements to be adopted by the Government of Turkmenistan. Currendy, the existence of multipl operative exchange rates results in a confusing system of implicit taxation and subsidizaton among state enteprises and other sectors. The elmmnaion of these distortions is necessary to reform the enterprise sector. 18. The Govermment of TurIlunistan is having discussions with the IMF on a stabilization program . While the IMP has provided tecnical assistance in the area of strngthening  fiscal institutions, enhancing the effectiveness of fiscal management, balance of payments and monetary reform, which has been usefil, futher discussions will be required before an agreement on a stabilization program is reached. B. Suctural Refonn Program 19. Price and Subsidies. Turlanenist has still an extensive system of subsidies and price controls which are not only one of causes of the budget deficit but also distort relative prices and slow the adjustment process. Incorrect price signals result in a lower growth rate of output than would be the case if relative prices reflected the real value of resources. Rationalization of the subsidy and price system is a pre-condition for macroeconomic stabilization and restructuring of the financial, agricultual and enterprise sector and the development of an efficient private sector. Relative prices should influence and guide decisions on production and consumption,, uch that those goods and services which can be produced most efficiently will be produced. Reforms of the subsidy system should aim at eliminating subsidies that have the largest distortionary effect on the incentive structure. Many of these are implicit subsidies which arise when domestic prices are set below the world prices for the particular commodity like in the energy sector. Implicit subsidies also arise in the financial sector, where credits are provided at negative real interest rates since when the loan is paid back it is wortb much less than when it was contracted. 20. Pnivatzation and Private Sector Development. Privatization has been slow. The Government's privatization program acrrently comprises only privatization of small-scale service units and began on December 1, 1993. The Government is still preparing a full privatization strategy to be implemented in stages. Several laws have been enacted; however, the Government lacks an overatl privatization strategy and relevant national experience for assessing the difficulties and benefits of alternative privatization policies. 21. The current laws and regulations give priority to transferring the enterprises to their current staff, who enjoy various discounts. Initial privatization has involved only the workers as new owners or lease-holders of the enterprises, without any competitive sale. However, heavy reliance on transfers to workers would limit the economic benefits of privatization as it proceeds, since the current staff can seldom meet alone the enterprises's needs for investment and operating improvements in a market economy. Current policies have also emphasized the use of the retention of state shareholdings, or the placing of various obligations on the privatized enterprises. These practices also curtail privatization benefits, because they limit the long-term motivation and commitment of the private operators. The initially implemented policies now have to be revised to allow for competitive sales of enterprises in order to reap the full benefits of privatization. Standard privatization modes further need to be refined according to enterprise size, profitability or sector constraints (e.g., competitive bidding for large profitable enterprises, possible transfers to staff for small profitable enterprises, and auctions for other enterprises). 22. The elaboration of a comprehensive and successful strategy for privatization needs to be accompanied by measures to strengthen the governance of enterprises that will not be privatized immediately. The Govermment needs to transform State Owned Enterprises (SOEs) into corporate entities mnaged according to commercial law; and abstain from new projects that can be done by the private sector. Furthermore, credit to enterprises should be conditioned on resntucring or liquidation plans for clearly nonviable enterprises.  -.5- 23. The regulatory, legislative, and economic environment for private investment is rudimentary, with inadequate safeguards. It needs improvement to remove existing constraints and promote private sector development. Furthermore, different incentives are applied to private and public enterprises. State enterprises should not benefit from preferential credit extended by the banking system - or from direct state subsidies in manufacuring and agriculture. 24. FinancAl Sector Reform. The financial system in Turhnenistan consists of a central bank, two specialized state banks, and twenty commercial banks. The ministries ad the public enterprises are major shareholders in most commercial banks. Experience shows that weakness ir. the financial system has been one of the most serious obscles in the transition to a market economy. Financial systems play an extremely important role in a market economy in terms of mobilizing resources and allocating credit for productive economic activities. To achieve the objectives of financial reform, changes are needed in policies and institutions that affect the intermediation of financial flows. Changes are likewise needed in the incentive structure that businesses and individuals encounter in their financial decision making process. The interest rate subsidies and directed credit programs to the enterprise sector do not allow for the application of sound banking criteria and the aKcwation of funds to the most productive activities. Reforms are also necessary to liberalize and commercialize the financial system, improve the payments system, strenghen the Central Bank, and reform the legal, accounting, and prudential framework. 25. Reforms need to focus on ownership, control, and competition A strong Government presence in the ownership of the banks (including indirect ownership through state-owned enterprises) and control resuts in the Government using the bankig system for its financial and credit needs at the expense of the private sector. The issues of ownership and control are, therefore, important underlying considerations because they shape the institutions and activities that constitute the financial sector. To encourage competition, one approach is a staged increase in the number of bakidng institutions and the scope of activities based on demonstrated performance. 26. Resource Management. The Government needs to strengthen the institutional frmework for economic policymaling. There is little capacity to analyze economic developments. Addidonally, there is a critical need to create the capacity to manage and invest the potential export surpluses to maximize the rate of return. The Government, therefore, needs to build up its capacity to evaluate the cost and benefits of projects. A public investment plan should include economically and financially sound investment projects on the basis of a careful cost-benefit analysis. The plan's sectoral composition should follow a national development stategy elaborated by the Goverrnment. Projected annual expenditures - built up from the forecasts for each project - should match the financial resources available. And the foreign exchange impact should be consistent with developments in the balance of payments. 27. Ial Framework. In order to strengthen private sector development, there is a need to address significant gaps in property, contract, and bankruptcy laws; to harmonize existing legislation affecting foreign and domestic investors; and to strengthen the capacity to enforce the legal regime. The success of the privatization of land and state enterprises also requires that decision makers need to be assured of the right to retain the eturns from their investments through appropriate laws. Initial legislative procedures need to be established so that individuals and firms have the meam to enforce legitimate contracts which will foster competition and innovation.  -- 28. Sodal Setoi Refonr. Since Turlmenistan's social indicators are amon3st the lowest in the FSU, targeted and cost-effective measures are needed to alleviate the hardship of the most vulnerable groups. The current social safety net system is not capable to deal with the social effects of an emerging market economy. When the Govemment implements major market oriented reforms it will need to restructure the social protection system in order to asust those negatively affected. For the system to be affordable, social benefits should be focused on the poor, while remaining conducive to effective administration. C. Sector Stragi 29. Eergy. Turklnenistan's ener sector offers good prospects for generaing significant foreign exchange earngs and provides a basis for improved creditworthiness. But the prospects for the natural gas sector are clouded by low remainig proven reserves in developed fields, the limited capacity of the domestic idustry to identify and develop new reserves, and the uncerainties surrounding access to export markets. The domestic industry lacks the financial and technical resources to undertake the scale of development required to sustain production at recent levels, replenish and maitain an adequate level of reserves, and to stengthn the cash generation and reinvestment capacity of enterprises to avoid premature loss of sector capacity. Additionally, the Government needs to overcome the country's constraints on the export of gas by developing an alternative pipeline route for hard currency markets. The Govemment, with the help of consultants, is reviewing pipeline options and the demand and costs of a pipeline to Turkey, but studies done so far are preliminary. The costs of developing the oil and gas sector are beyond the country's financing capacity. These challenges can be met if the Government attracts foreign expertise and capital to regenerate the sector's production potential and help diversify the export markets. 30. Agricultu Litae has been done so far to reform the agriculural sector in terms of reducing government control. The priority in agriculture is to liberalize prices and establish a proper system of ownership. State production orders need to be eliminated to allow the market to work. Input subsidies should be phased out, and food prices allowed to adjust to market lk.els. Price liberalization should be accompanied by the liberalization of distnbution and trading, as well as by allowing imports and exports to provide alternative sources of commodities to state monopolies and help develop the domestic private marketing system. A hard budget constraint is yet to be imposed on all state and collective fam, accompanied by lifing all geographical restrictions on buying inputs and selling outputs. Once the instutional and legal framwork is put in place, privaadzation of small- scale agro-processing enterprises, input dealerships, and retail food outlet can begin. Furtmoe, sectoral policies should be implemented including the withdrawal of the state from the direct distribution of agricultural inputs; the privatization of most processing, wholesale and retail trade; the development of small-scale transport operations; and the reform of agricutural credit, research, information, and markeing services. 31. Transport/Telecommdncatons. Turkmenistn's geographic remoteness from hard- currency markets makes adequate transport and intemational telecommunications particularly important. The availability of transportation is critical for the competitiveness of agriculture and the industial sector. Transport costs are highly subsidized, and thus these costs are given litle consideration in production decisions. In reforming this sector the eliminaton of these subsidies and privatization is a key requirement.  -7- D. Medim-Term Prospects 32. Despite its high proportion of desert land, Turkmenistan has st economic potential. Eamngs from energy exports could be substantial if the resources are developed, and there is considerable scope for raising the productivity of irrigated land. However, Turkhenis is tied by innumerable link to the FSU, and there is great uncaity surrounding the evolution of interrpublican trade and the ability of other FSU countries to pay for their imports from Iurkbenista,. Hard currffency revenues will continue to be uncertain as long as the country is dependent on Russia and Ukine for transport and access to hard wrency murkets; and, unless the country is able te develop its capacity to transport and market its energy and other exports to non- FSU markets. Since energy is the major source cf exports, a decline in the price of energy can lead to senous long-tern problems such as soaring budget and balance-of-payments deficits and declining growth. Furherm e, the same effects would be caused -y an incrase in transport charges, since Turkmenistan has little leverage over the determination of regional gas transit ta. A decline in the price of cotton, which is the other major export, would have a similar but less severe impact on the budget and balance of payments deficits, and growth. A decisive implementation of a comprehnsive reform program, combined with policies to diversify export markets and exports, could reduce the vulnerability to these potential eernal risks. 33. The Government is engaged in formulating a revised long-term strategy for addressing the key problems facing the domestic energy industry especially access to foreign markets. Cental to Turkmenistan's development potenti is the efficient re-investment of financial domestic resources obtained from the energy sector. However, smce the development of the energy sector will reqire very large financial resources well beyond the capacity of the country, the Government will have to atract foreign technology and capital. Financial assistance will have to be sourced mainly from foreign direct investment (FDI) and loans from international comercial bas. In addition to an adequate framework for I7DI, the immediate enal financing task is, therore, to build up access to internationad capital markets. 34. So far, the Government has focussed its development stratey on the energy sector. However, the Govermment has to address also domestic economic policies especialy the issue of relative prices. There has been a lack of progress on stucural reforms so far. Failure to reform can lead to serious problems even in resource-rich ouries like Turkmenistan. If reforms are not implemented and existing structures are perpetuated, the-reallocation of resources to new operations will not take place. Without privatization, private sector response will be limited and efficiency gains from increased domestic con :tition will be delayed. Progress on systemic reforms would provide enterprises and individuals widz the right institutional and incentive stuces and stregten substantially the supply response in the economy. Furihemore, the very slow implementation of reforms could cause severe macroeconomic problems like growing budget deficits and inflation. 35. Other rnsks include the possibility of severe supply dislocations in the FSU, especially in Russia. Shortfalls cannot be easily made up by recourse to other sources, given Turkmenist's remoteness. So there could be considerable supply bottlenecks provoked by a shortage of raw materials, itmediate goods, spare parts and replacements for capital goods.  -8- E. World Bank Activities 36. The Bank has had discussions with the Government on structural reforms, as well as the Bank's future lending activities in the course of preparation of the IBTA project, Following the introduction of the new currency, the Government has been proceeding with structural reforms, albeit at a slower pace than most other FSU countries. The Govenment. ho*ever, would like to move more rapidly with reforms to develop Turknenistan's potential and srengthen the sustainability of the supply response in the economy. The Government recognizes that the limitations in domestic capacity and shortage of skills need also to be addressed. 37. The Bank has a broa4 understanding of structural transformation issues facing the country; the Bank's knowledge of the economy, and in particular the sectors other than energy, is limited. These are being strengthened by planmed economio and sector work. The Bank's assistance progm aims to support Turkmemistan in its transition toward econotwc stabilization and a nwaket- based economy through policy advice, economic and sector work, and investment lending. lTe Bank does not yet have a comprehensive country assistnce strategy for Turlmenistan. Howover, the Bank is having further discuss.ons with the Government and is developing the elements of stch a comprehensive strategy. 38. The Bank is planning to develop about one to two projects per year over fiscal 1995- 1997, with an annual lending program of about US$50 million. The lending program is expected to focus on investment, and institution building and technical assistance projects. The investaient lending would support the reforming sectors and include the necessary policy conditionality aimed at increasing the efficiency of resource use and expanding exports through diversification mimarkets outside the FSU. 39. A key aspect of the Bank's initial assistance would be the developmeni of the. Government's institutional capacity, for which this proposed Loan is designed.' Following this first loan, and in view of the importance of agriculture to Turkmenistan's economy, the Banki is considering the financing of a project. in agriculture on farm restuctring and privadzation to enne and expand production in Fiscal Year 1996. The Bank would also support the Govermnent in attating private sector financing for the developrent of the oil and gas sector. hi June 1994 the Bank cosponsored with the Government an international investors conference, with the objective of mobilizing private sector resources in the oil and gas sector. In view of the success of the. conference, the Government is considering holding in the future such conferences for projects in this and other sectors. 40. The Bank is also considering the possibility of a project in the health sector, aimed at improving the quality of water sanitation and health in FY96. An irrigation rehabilitation project is being considered to support the Govermnent's reform efforts on efficient water use, in conjunction with the Bank's regional work on the Aral Sea, which would also address the issues of strengthening environmental agencies and improving enviromnenal regulations. The Bank is fiurher considering an infastructure project in transport or power sectors in FY97. For other years (FY98 and beyond) the Bank would consider a human resource development project to address education or social protecton, in which the Bank would help the Govermnent develop instruments to target social assistance and to deal with poverty, and other projects in energy and agriculture.  -9- 41. EconoIc and Sector Work. The Bank's economic and sector work on Turkmenstan will form the basis for policy advice and design of the lending program. The first CEM has been issued which includes the Bank's initial economic assessment of the country's macrenomic framework, structural and sectoral characteristics, and prospects and constraints for medium-term growth. It contains a reform agenda for the transition to a market-based economy. An energy sector review which sets out the sector's performance, prospects and constraints, is expected to be finalized in FY95. Annual economnic updates will be prepared to assess progress m economic reform and update macroeconomic developments. A number of sectoral studies would be nitiated, including a review of the health sector in the current fiscal year which will include the results of a water quality study, and reviews of the agriculture and inrastructure sectors. These reviews will provide the framework for dialogue on policy issues and lending operations in specific sectors. 42. Other Bank Group Activities. Turlanerstan is a member of the Multilateral Investment Guarantee Agency (MIGA). It is not yet, however, a member of te International Finance Corporation (IFC). These agencies do not yet have any operations in Turkmenistan. IV. TIE PROJECT 43. Background and Project Rationale. The components to be financed under the Loan reflect the needs of the Government and are aimed at strengthening the institutional capacity and supporting the development of policies to aid the reform program. To avoid possible overlap, the Bank Lo takes into account proposed assistance to be provided by other agencies, such as the European Union, United States Agency for International Development (USAID), Turkdsh Intenational Cooperation Agency, and the IMF. The Bank's overall strategy is to assist the Government in its transition toward a market-based economy. To help the Government attain its objectives, concrete assistance of both a short and longer term nature is required, particularly in the high priority areas identified by the Government that will lead to overall reforms. The proposed Loan would be the Bank's -first to Turkmenistan and by supporing a limited number of high priority areas it will help the Government to resucre the economy. It will also ensure that appropriate reform policies and the needed institutional framework for their effective impletation are developed soon. The timely response to the Government's most pressing needs will enable the Bank to ensure that technical assistance from other donors is also directed to priority areas. 44. Project Objectives. The main objectives of the proposed Loan are: (i) to provide support to the Government in the policy formulation process by helping to overcome the critical human resource gap that is slowing the preparation of a reform program; and, (ii) to provide support for institutional building and strengthen domestic capacity to ensure that Turianenistan has the capability to implement and sustain reforms over the medium term. 45. Projedct Description. The project would finance technical assistance and selected equipment needs in the amount of US$26 million for: (a) Privatization and Private Sector Development: This componet would provide assistance to help the Government to: (i) develop a comprehensive privatization strategy for state owned enterprises, including the adequacy of legision; (ii) design procedures for quick privatization of small and medium scale enterprises; and (iii) improve the governance of enterprises which will not be immediately privatized.  10- The component would also help detennine the constraints (including legal) to private sector development, identify barriers to competition, and other constraints, such as preferential access to credit, local and imported inputs, and propose measures for eliminatng these constraints. Furthermore, the proposed component would provide necessary assistance for selected enterprise restructuring. (b) Financial Sector Reform: This component would: (i) provide assistance to the Central Bank in modenizing the country's payments systms, including the financing of equipment; (ii) strengthen the Central Bank's supavisory function and the prudential reguations to eue sound commercial banking strucures and practices; (iii) provide expert assistance in revisi accounting and auditing systems for the commercial baking sector; and, (iv) provide training to key proftssional groups of commercial and central banking staff in the areas of, for example, leding, credit and financial analysis and management. (c) Institutional Support and Development: This component would comprise the following: (i) Public Investment Plroject Analysis: This subcomponent would develop capacity in the Government to carry out economic and financial evaluaton of projects to identify high priority and high retur investments, which are consistent with national and seceoral priorities, for funding in the public investment program. This component would assist in capacity building at the levels of the Ministry of Ecomy and Finance (MOEF), as well as the sector ministries. (ii) Lega Reform: This subcomponent would finance experts to help the Government to review existing laws and modifting them in te light of experience of socialist economies in transition. Many basic laws, such as those on ownership, company law, bankruptcy, and contracts, need to be reviewed. (iii) Feasibity Studies: This subcomponent would finance the feasibility studies of major projects in the infrastructure, industry and agriculture sectors. (d) Social Safety Net: This component would cover: (1) a living standards measurement survey and the design of a monitoring system; and (2) the review and design of a voluntary pension scheme and pension fund policies to cover private sector employees and improve pension administion. (e) Energy Sector (Oil and Gas): This component would support: (i) the establishment in the Ministry of Oil and Gas (MOO) of monitoring and supervisory capacity for contract a n and joint ventues in oil and gas; and (ii) training activities in management, fiance and planning and in technical/technological aspects for the staff of the Ministry of Oil and Gas. 46. Past Bank Projects. As the Bank has no prior project experience in Turkmnistan, the design of this project takes into account the Bank's substani experience with institutionl development operations in other countries, mcluding countries in Central Asia. Reviews of past institution building/eechoical assistance loans suggest that projects are more effective when developed  -11- in the context of the Govenm's instttional development objectives. Other lessons relate to the need for Government commitment, ownership, and involvement ir. the specification of the particular program; agreement on project coordination, and detailed terms ot reference prior to the initiation of the program; and training, and intensive supervision by the Bank once project implementation has begun. The design of this operation has taken these factors and lessons into account. 47. Project Ad saion. The Secretariat of the Cabinet of Ministers would serve as the Lead Authority for the management of the proposed Loan and the coordination of its implementation. This Lead Authority would represent the Borrower and would be the focal point for relations between the Government and the Bank. A Project Implementation Unit (PIU), under the authority of the Cabinet of Ministers, has been established with responsibility for the overall implementation of the Technical Assistance Loan and the related reporting and accounting activities. Given the wide scope and importance of its assigned fucions, the PIU has been given the authority and stature to deal directly and effectively with the Baik, govemment ministries and offices, as well as the Central and commercial bans and other project beneficiaries. The PIU is headed by a full time Manager who would have overall responsibility for the project. The PIU Manager would be assisted by a Financial Manager with responsibility for project management, finance and accounting, and a Procurement Manager who would advise and assist on all procurement procedures and monitor their implementation. These consultants, designated as Progran Coordinators, would focus on the administration and organization of technical assistance as well as related financial matters, and procurement; and ensure that the scheduling of technical assistance allows timely availability of results that can be used in the development and implementation of the program. 48. The consultants will work with counterpart agencies, co-ordinate with other technical assistance consultants, monitor the progress of the technical assistance programs, and ensure the communication of results to the Cabinet of Ministers and the World Bank. They would work in close cooperation with the PIU and provide on-the-job training of its staff. The PIU subcomponent will be implemented at an early date and the terms of reference for the consultants have been prepared. 49. Io Admsan and Procurent. A large part of the list of goods and services financed under the proposed Loan would deal with procurement of consulting assigmnents, and the fmancing of a limited amount of goods and services, including hardware and software. The proposed Loan is also expected to put in place the institutional capacity to support subsequent World Bank operations. 50. The counterpart ministries, banks and other beneficiaries would be responsible for the development and agreement of the final terms of reference, short lists, bidding process and negotiating, signing and executing contracts. However, the PIU would assist in and oversee the work of the counterpart agencies in these areas, endorse the contracts, and approve disburments. 51. To ensure effective project implementation, after loan approval the Bank wilU send a team, including a task manager, procurement, disbursement and some of the component specialists, who will hold a project launch workshop to ensure that all counterparts fully understand prvper procedures for mplementation. This would include Bank approval of the terms of reference of studies and programs financed under the project, the criteria for selection of trainees, and the short list of consultants. The Bank will subsequeny conduct a midterm review of all components, as well as interim reviews as needed. The Borrower and the Bank would jointly review the findigs of the studies and the results of trauiing programs. To enable early project start-up and implementation,  -12- the Loan provides retroactive financing of up to 10 percent of the loam amount for expendiures incurred since January 1994 for goods and services procured in accordance with the Bank's procurement pcices. Additionally, to provide flexibility. the Loan provides a price and contingency reserve which will be used as the need arises. 52. Envin t Aspect This project is not expected to have any significant negative environmental impact and has been rated "C" in accordance with Operational Directive 4.01 on Environmental Assessment. In view of the 'C' rating and as large enterprise privatization is not expected to take place in the imunediate future, no environmental assessment is necessary. 53. AcIns Agreed. The agrments reached at Negotiations are on: (i) the scope of technical assistance to be financed under the Loan; (ii) the project costs and the financing plan; (iii) the project arrangements, in particular as regards the establishment and maintenance of the PIU and the Legal Reform Unit (LRU), including the appointment of critical staff and the introduction of accounting and reporting systems, and procurement arrangements; (iv) the arrangements for the appointment of auditors for the Loan; (v) arrangements with the Govermment to provide the Bank with a statement showing all its foreign debt obligations and maintaining a system of debt reporting; (vi) increasing the staffing of the supervision function in the CBT to 14 professionals by February 28, 1995; (vii) a project implementation plan; and (viii) that prior agreement will be sought with the Bank on: (a) the content of training programs and criteria for the selection of trainees; (b) short lists for consultants; and (c) the terms of reference of studies. The findings of these studies would be discussed with the Bank. The Government has appointed the head and other key staff of the PIU, fulfilling the condition of Board presentation. The appointment of a firm to assist the Govermment/PmU to implement the project would be a condition of effectiveness. The establishment of the LRU would be a condition of disbursements for the legal subcomponent. 54. Benefits and Risks. The Government of Turkmenistan currently has limited institutional capacity and the needed human resource skills to design and implement reforms, and formulate strategies. The proposed Loan would help alleviate the constraints arising from the lack of specific sklls, as well as strengthen the Government's capacity to formulate and implement reforms which are essential for the development and operation of a market economy. It will also strengthen the instiutional framework for mobilizing- and coordinating technical assistance for implementing reforms. 55. The main risks relate to: (i) changes in resolve or commitment by the Goverment to the reform effort; (ii) limited administrative capacity and lack of familiarity with Bank procement and disbursement procedures, which could lead to implementation delays; and, (iii) the Govenment's inexpenence with managing technical assistance. There is currently strong evidence of commiment by the counterparts who need such assistance at both the cabinet and agency levels. Additionaly, the technical assistance conmponents provided to the critical ministries and agencies are aimed at assisting in the preparation of their respective reform programs, and would reflect the Govermment's prorities. Close supervision during implementation will assure that inefficiencies are addressed as needed. Procurement and disbursement risks will be reduced through close attention to procurement and odw implementaton constraints during project supervision.  -13- 56. Rcm don I am satisfied that the proposed Loan would comply wit he Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed Loan. Lewis T. Preston President Attacments Washington, D.C. August 25, 1994  -14- Schedue A Page 1 of 2 INSTITUTION BUILDING/TECHNICAL ASSISTANCE PROJECT Detailed Projed Costs (t*ousads of U.S. doflm) Foreign Component Costs Costs asa%of asa%of Cost Components Local Foreign Total Total Costs Total Costs 1. Privatiation and Private Sector Developmet a. Privadzation 200 950 1,150 82-6 4A b. Enterprise Refonn 100 850 950 89.5 3.7 2. FInancial Sector a. Bank Supervision 70 350 420 83.3 1.6 b. Accounting and Auditing 30 230 260 88WS 1.0 c. Training 150 1,200 1,350 88.9 5.2 d. Payments System 500 6,300 6,800 92.6 26.2 3. Inst1tutimal Support and Development a. Invesgment Project Aoalysis 310 2,130 2,440 87.3 9.4 b. Legal Reform and Framework 110 850 960 88.5 3.7 c. Project Feasibility Studies 200 2.200 2,400 91.7 92 4. Social Safety Net a. Living Sandards Measurement Survey 40 350 390 89.7 0.2 b. Pension 70 500 570 87.7 2,2 S. Enr Sector (Ol