Uzbekistan - Agricultural Sector Framework Paper

CONFIDENTIAL iS oCV7-uz 15097-U Z CONFIDENTIAL Republic of Uzbekistan Agricultural Sector Framework Paper October 26, 1995 Agriculture, Industry and Finance Division Country Department W91 Europe and Central Asia Region FL COPy Document of the World Bank CONTENTS Overview of the Sector ............................................ 1 Agricultural Sector Reforms......................................... 3 Impact of Reforms ............................................. 10 Role of the W orldBank .......................................... 12 REPUBLIC OF UZBEKISTAN AGRICULTURAL SECTOR FRAMEWORK PAPER Overview of the Sector 1. Agriculture represents both the promise and challenge for Uzbekistan's future. It is the promise for the future because of its potential for increased production and employment generation. The sector has a central role to play in halting the economy's decline and contributing to future growth, poverty alleviation and development. To achieve that potential, the Government faces the challenge of formulating and implementing a comprehensive strategy supported by effective policies and investment programs. Restored growth and development of agriculture is absolutely essential for the economy because of its substantial contribution to GDP, export earnings and employment. The sector is blessed with a favorable climate, an extensive irrigation infrastructure, and skilled manpower. It, thus, has the potential to contribute significantly to future economic development. To assure that this potential is realized, Government faces the difficult task of reforming the sector and fostering its transition from a command system to a competitive market- oriented system. This paper identifies the key constraints in the sector, discusses reform measures to address these constraints, and identifies how World Bank assistance could assist the Government in. meeting the challenge it faces in agriculture. 2. Agriculture in Uzbekistan accounts for around 30 percent of GDP, among the largest shares for any of the Former Soviet Union (FSU) countries. It contributes about 60 percent of Uzbekistan's export earnings, largely due to cotton exports, and accounts for about 40 percent of total employment. Given the extremely arid climate, nearly all of the approximately 4.5 million hectares under cultivation are irrigated through a large scale system, most of which is in need of rehabilitation or upgrading. Much of the remaining 23 million hectares classified as agricultural land consists of seasonal grazing areas. Cotton is the most important crop in terms of value of output and area planted, followed by wheat, rice, and a variety of fruits and vegetables. Livestock production which includes beef, sheep, dairy products, and wool, has been a major source of growth in the sector. 3. Rural Populadon. Uzbekistan is basically a rural country. About 60 percent of its 23 million people live in rural areas and are dependant either directly or indirectly on agriculture. Most of this rural population lives in the arable areas and population density relative to arable lands is quite high at about three people for each hectare. With population growing at 2.4 percent per year and given the limited capacity in the non-rural sector to absorb this increase, the pressure on arable land is increasing. Living conditions in rural areas have become more difficult since independence because of declining real incomes and deteriorating social services. Uzbekistan has been one of the poorer regions of the FSU and most of the poverty has been in rural areas. The poverty situation This paper was prepared by Salem Gafsi and Roy Southworth (EC3AI). Substantive contributions were made by Michael A. Gould (EC3AI), Parvez Hasan (EC3TA), Robert J. Anderson and Silvina Vatnick (EC3C1), Laura Tuck (ECAVP) and Alberto Valdes (LATAD). The draft version of this paper was revised to reflect the outcome of discussions held with Government in September 1995. -2- has been exacerbated since independence by the growing economic crisis. Most rural people live and work on about 2000 former state farms that recently have been transformed into collective farms. As elsewhere in the FSU, farm workers have been allocated small household plots, averaging 0.2 ha, to supplement household food supplies and incomes. Recently, the Government has given about 14,250 private farmers the right to use land allocated from collectives and former state farms. These private farmers control an average farm size of about 60 hectares. 4. Performance of the Sector. In contrast to other FSU countries where agricultural output declined by 20 to 40 percent, agricultural production did not collapse in Uzbekistan after independence. Gross agricultural output in 1994 was less than 10 percent lower than at independence. Two factors explain Uzbekistan's ability to sustain production. First, it produces fertilizer, pesticides and some agricultural equipment, and, thus, its ability to supply essential agricultural inputs was not as badly affected as elsewhere by the collapse of trade links with the rest of the FSU. Second, it has been able to find alternative, non-FSU markets for its cotton exports, allowing it to finance imports much more readily then other FSU countries which suffered dramatic declines in demand for their agricultural exports. 5.. Uzbekistan's ability to sustain and improve production was clearly hampered by a system of state procurement and pricing that pays producers only a small fraction of world market prices for their output. This system has levied a burdensome tax on the incomes of farms and their workers that was estimated at about $1.1 billion in 1993 even after deducting subsides for inputs, water and credit. The net effect of the price regime has been a heavily taxed agricultural sector which negatively impacted its performance. Efficiency of investment in agriculture under the command system was never very high as output growth never matched population growth despite massive investment to expand irrigated farming. Yields per hectare are comparable to those found in many middle income countries. They are, however, below yields in developed countries with similar soil and climatic conditions. Also, yields per kilogram of fertilizer and per cubic meter of irrigation water are low by international standards. Low productivity has been exacerbated by the increase in marginal lands being brought under cultivation. 6. Excessive emphasis on expanding irrigation created both environmental and efficiency problems, including, high water losses, excessive water use, and associated waterlogging, increased soil salinity, declining water quality, and deterioration of the Aral Sea. The original design of the systems did not allow for efficient use of water. Many of the canals are not lined and suffer water losses in the range of 40 to 60 percent through seepage. Moreover, the allocation of water based on planning norms often led to excessive deliveries to individual fields and the producers have had no incentive to economize on the use of this water which they receive free of charge. About half the irrigated area is affected by salinity and more than a fourth is affected by waterlogging due to insufficient drainage. Excessive fertilizer use has also contributed to soil degradation and declining soil quality through run-off into streams and rivers. 7. The Government has been aware of this situation and has taken initiatives to redress it. A soil survey is underway to provide farmers with a basis to determine the need for fertilizers. Under the Cotton Sub-Sector Improvement Project, provision was made for strengthening the Integrated Pest Management Program aimed at reducing the use of chemical pesticides and -3- integrating them with biological control methods. Provision was also made for developing methodologies for improving the application and management of irrigation water. In addition, the Aral Sea Program has provided a forum for international cooperation to develop approaches to combating water and agro-chemical based pollution. Agricultural Sector Reforms 8. The Government of Uzbekistan faces a daunting challenge in seeking to improve efficiency and sustainability in agriculture, restore growth in output and exports, and tackle the persistent problem of rural poverty. To meet this challenge, the Government has sought to forge an economic reform program to transform the command economy to a market based system. For the first two years after independence, the Government was cautious in reforms. Some prices were liberalized, small shops and houses were privatized, and preliminary work was undertaken on a legal foundation for a market economy. But, for the most part, Government retained central control of most economic activity during these two years. 9. Alarmed by the deterioration in the economy in 1993, the Government decided to embrace more comprehensive reforms for 1994 and beyond. The Government moved on a broad front during 1994 and 1995 to liberalize prices and trade, control budget deficits, tighten credit, create foreign exchange markets, strengthen the banking system, accelerate privatization, and target social assistance. Specific reform measures in agriculture implemented during the period include the following: * Adoption of a timetable for the elimination of state orders for all agricultural commodities. All state orders have been eliminated except for grain and cotton. For grain state orders have been reduced to 50 percent of production for 1995. They will be further reduced to 25 percent in 1996, and eliminated altogether in the following year. The producer price for grain was raised to 70 percent of world market prices for 1995. For cotton, state orders will be. eliminated by 1998, with the share for 1995 pegged at 60 percent. The producer price for the 1995 cotton crop is expected to be increased to 60 percent of world market prices; * Reduction in the net taxation of agriculture; * Introduction of competitive tendering with voluntary participation for state purchases of agricultural commodities not subject to state orders; * Elimination of export licensing requirements for all agricultural commodities except cotton; for cotton, elimination of licensing requirements for cotton traded on the Republican Commodities exchange, and agreement on simplified licensing requirements for producers wishing to export cotton in excess of state order requirements; -4- * Unification of the foreign exchange rate and deepening of the inter-bank foreign exchange market through establishment of bi-weekly auctions. Centralized exports and imports are now channelled through the official auctions under a surrender requirement of 100 percent. Any other trade transaction is subject to a 30 percent surrender requirement. The Government intends to reach full current account convertibility by the end of 1995; and * Expansion of farm restructuring initiatives, including transformation of nearly all state farms to some form of collective enterprises, experiments with different techniques to further distribute land rights and equipment to farmers and continued emphasis on the establishment of private farms. 10. The accelerated reforms of the last 18 months have set Uzbekistan firmly on the path to a market-based agricultural economy. New farm structures are beginning to emerge, alternative market channels are developing, particularly for livestock, fruits, and vegetables, and the heavy implicit tax on the sector through Government price and procurement policy is gradually being lifted. The pace and scope of the recent reform efforts are indeed impressive. Nevertheless, much more remains to be done. Despite steps that have been taken, a truly independent, market-oriented agriculture has yet to emerge. The control structure of farms is evolving but few are independent from administrative controls and planning directives from Government. Price controls and state orders are being reduced in scope, but producers still face limited marketing alternatives for their output, particularly for cotton and grain, and the prices they earn are significantly lower than world market levels. Implicit subsidies on water, electricity and natural gas serve to perpetuate inefficiencies in agricultural production. 11. To speed the transition to a market-based system, Government needs to further intensify its reforms in agriculture. Additional measures are needed to: (i) improve the incentive structure through further reform of pricing, procurement and trade policies; (ii) promote competition in input supply, marketing and processing through demonopolization of state agri-enterprises and creation of an environment conducive to new private entrants; (iii) restructure farms, define rights to farm assets and land, and promote entry and exit; (iv) improve water management; and (v) redefine the role of government. 12. Improved Incentive Structure in Agricufture. The Government decision to reduce both the volume and scope of state orders is key to a successful reform effort and should begin to reduce substantially the implicit taxation of the sector. The focus for 1995 and 1996 should be on assuring that plans for reduced state orders are implemented and that payments to grain and cotton producers of the higher procurement prices are timely. The Government should also explore alternative options for developing effective marketing channels. The new system for Government procurement for commodities no longer subject to state orders can help to foster emergence of competitive markets. The Government's decision to introduce competitive tenders for state requirements with voluntary participation is an important step in this direction. The Government should now focus on developing procurement guidelines and regulations that would allow for the -5- decentralization of the procurement function to the various public consumers such as the military, and the health and education systems. 13. Further trade reform is also required to improve the incentive environment, particularly for cotton. Currently, two restrictions hamper private cotton exports. First, exemptions from cotton licensing requirements are only available for cotton sold on the Republican Commodity Exchange, even though a number of other channels are available to farmers. Second, for trade outside the Republican Exchange, licenses are restricted to cotton producers, so that merchants are currently unable to buy cotton from producers, have it ginned, and export it. Both these restrictions reduce the choices available to producers and represent an unnecessary restraint on trade that should be removed. Finally, the temporary 30 percent foreign exchange surrender requirement at the market exchange rate for all exports should be eliminated as soon as possible. Government sees trade reform as a step-by-step process proceeding at a pace commensurate with the development of the domestic marketing channels. While recognizing that more can be done to improve access to both import and export licenses, the Government is of the view that a more important constraint to private sector participation in cotton export and input supply is the dearth of private traders and input suppliers which is as a result of limited access to financing. The Government, therefore, views support to private entrepreneurship development as the top priority to bring about free trade. An interim solution being considered by Government would be to extent access to export licenses to agro-firms, pending the development of truly independent entrepreneurship. 14. The lack of appropriate cotton grading and classification unnecessarily drives a wedge between prices received for exports and world market prices. Support for establishing a national capacity to grade cotton to international standards is provided in the Bank financed Cotton Sub-sector Improvement Project. Rapid implementation of such a system should improve the prices paid for exports. The project provides for the establishment of an autonomous agency to classify all cotton and to assemble and disseminate information on cotton grades to producers, the research establishment and international cotton markets. The availability of an internationally recognized system of cotton classification should help broaden interest in Uzbek Cotton on world markets, increase the number of buyers, and enhance its value. Similarly improvements in ginning could improve both quality and quantity of lint. 15. Ensuring Competidve Markets forAgri-Services. Eliminating state orders and ending Government price controls are necessary but not sufficient to ensure competitive markets in agriculture. Producers continue to face state owned monopsonistic buyers for their output and buy their inputs from monopolistic input distributors. The Government should focus on demonopolizing these state enterprises in a way that ensures competition will result. Turning state monopolies into private monopolies will not improve their performance. Each sub-sector should be thoroughly examined to determine how to encourage entry of new marketing agents, product processors and input distributors to promote competition and efficiency in the provision of services. 16. The highest priorities for agricultural demonopolization are the cotton and grain markets and input supply. For cotton, a simple first step would be to end the administrative controls on where producers are allowed to gin their cotton. The focus should also be on demonopolizing Uzkhlopkoprom, the state owned ginning organization that controls all ginning activities in the 122 -6- gins in the country. Equally important is the demonopolization of Uzkheboproduct, the state owned concern responsible for the purchase, processing and sale of all bread and grain products in the country. It owns a large complex of storage facilities, flour mills, and bakeries. A careful assessment of how to open it up to competition is required. Finally the input supply enterprises operated by the Ministry of Agriculture and the fruits and vegetables processing facilities operated by Uzplodoovoshvinprom should be opened to competition by allowing new entry and should be demonopolized as quickly as possible. 17. With regard to cotton ginning, Government supports the concept of aemonopolization and is considering alternative ways to reform the present system. One option would lead to separation of the ginning and marketing operations. Under this scenario, ginneries would simply gin the cotton at a fee and return it to the farmers. The Government is also experimenting with the concept of agro-firms, whereby cooperative service agencies were created in three raions to provide input supply, ginning and marketing services on demand, thus grouping production, processing and marketing services in one agency controlled by its members. The Government, however, views the elimination of state orders as the main mechanism for demonopolization of the cotton gitming/marketing services. There is, therefore, convergence between the Bank's and the Government's views, but the dialogue needs to continue on the interim steps. In contrast to cotton, the Government does not support the demonopolization of trade in grain because of the importance of this commodity to political and social stability. The Government, however, is encouraging the demonopolization of the production and marketing of bread. There is, thus agreement between the Bank and Government on how to address the bread part of the grain trade issue. The dialogue should continue on the grain part. In relation to fruits and vegetables, the Government views Uzplodoovoshvinprom as a support agency under the control of its independent agro-firms through a voluntary association. The regional Departments of Uzplodoovoshvinprom were eliminated and agro-firms were established under the control of their service users. The agro-firms are considered as intermediary solution pending the development of private marketing and service supply channels. Dialogue between Government and the Bank should continue on how to encourage entry by private entrepreneurs into the marketing and processing of fruits and vegetables and how Uzplodoovoshvinprom can play a positive role in that process. 18. Privatization of state enterprises alone will not ensure that competitive markets emerge for agricultural commodities and inputs. Indeed, for many branches of the sector, particularly those dealing with livestock products and fruit and vegetable processing, the market share of state enterprises has either collapsed or the enterprises are so severely decapitalized that they will not be able to compete under any ownership arrangement. What is important for these sub-sectors is to ensure that the policy and institutional environment is conducive to the entry of new entrepreneurs and the development of competitive markets so that the emerging private sector will continue to grow and take over the functions of obsolete and defunct state enterprises. Among the most important elements in such an environment are court enforced civil law procedures which ensure and protect the freedom of entry and exit, and the security of contracts. Freedom of entry requires simple procedures for establishing companies. Licensing and documentation for registration should be standard and straight forward. The role of tht state should be to maintain a register of company information. It should not have any powers to make judgements on the potential viability of proposed companies, and existing companies should be able to change their activities by a simple -7- resolution of the shareholders. Exit is as important as entry to assure that assets are used in the most efficient manner as possible. Aside from voluntary exit of owners through sale, or closure of firms, creditors to firms in default on obligations should have the right to force exit on those firms through bankruptcy law. Adequate laws on the right to enter into and enforce the provisions of contracts are also essential components of a competitive system. Finally, Government can play an important role during the transition stage in supporting new businesses through the provision of training and advisory services. 19. Land Reform and Farm Restructuring. Uzbekistan has virtually no unexploited arable land, so future agricultural growth will have to come from more efficient and intensive use of existing cultivated areas. Such intensification will require shifting the control bver the existing farms to the private sector to make them more responsive to the improved incentives emerging from legal, policy, and institutional reforms. Uzbekistan has already embarked on a farm privatization program containing three distinct approaches. First, nearly all state farms have been removed from state control and the assets transferred to the workers. These farms currently function as collective farms. Similarly, livestock operations belonging to state farms were separated from the farms and organized as shareholder companies with the workers becoming the major shareholders, and some were auctioned to Private individuals. Second, provisions for establishment of small-holder family farms have been in place since 1992. Over 14,000 family farms were established under these provisions. They were carved out of existing state and collective farms under a leasing arrangement, and they often remained closely linked to the "parent" farm for inputs, marketing services and technical support. Finally, since independence, Government has rapidly expanded access to land for household plots. By 1994, total land in subsidiary household plots had reached close to 500,000 ha and the number of households with land exceeded 2.5 million. 20. The Government intends to encourage further restructuring of the collective farms. Temporary regulations adopted in June 1994 provide guidelines for division of non-land assets into individual shares to be distributed among the workers. These shares are then used to stimulate regrouping of the shareholders into collective sub-enterprises on the basis of approved business plans. Land, however, remains in the state's hand. Government has made the decision under the Cotton Sub-Sector Improvement Project to extend the lease period to 99 years. Moreover, a large amount of spontaneous restructuring and informal experimentation with different management structures is occurring often at the impetus of local authorities. Such efforts often take the form of "organized privatization" of collective farms, whereby land rights are allocated by committees established by local governments to individuals who, in the opinion of these committees, are potentially good farmers. 21. The Government's effort in farm restructuring contains a number of positive elements. Nevertheless, additional measures are required to rationalize and speed the process. First, the right to use and transfer land requires further clarification and a constitutional legal basis for it needs to be established. The objectives of farm restructuring measures should be to create markets to facilitate the movement of both land and non-land assets between groups and individuals to encourage the evolution of more efficient farm structures. The constitution requires that ownership of land remain with the state but it allows for lease of land to either collectives or individuals. Changes in the legal code are required to: (i) clarify the ability of the lease holders to transfer lease rights -8- through sale, sub-leasing, inheritance or other methods; (ii) strengthen incentives for long-term capital improvements by lengthening the lease period as was done under the Cotton Sub-Sector Improvement Project, and by providing for automatic lease renewal; and (iii) increase the security of lease tenure by explicitly limiting the ability of government officials to revoke land leases for failure to comply with "development covenants", restrictions on land use, or directives on cropping patterns. Development of a simple registration system to record land rights is also key to the emergence of trade in land entitlements and development of land markets. 22. Second, the Government can play a more active role in encouraging newly private collectives to restructure further. The process should be voluntary and market-based. It should neither preclude nor provide special incentives for development of particular types of farms. Collective farms should be free to split if they so desire into several large-scale enterprises owned either by individuals or groups. Individuals or small groups should be free to split from larger collective enterprises at any time, taking with them their entitlements to land and other assets if they desire to establish new enterprises. A transparent system for trading and selling entitlements should be developed to facilitate establishment of farms by new entrants and exit for those individuals no longer willing or able to farm. Market forces, resource endowment and the cropping patterns should lead the current farm organization to evolve, resulting in co-existing large collective farms, individually owned commercial farms, and small family farms. The transition to market-oriented farming based on private control over resources is bound to involve a wide range of ownership forms, farm sizes and management mechanisms. The Government should allow economic forces to direct the change in farm structure so that the most efficient and competitive farms emerge. It can facilitate the process by providing a public information program to inform farm workers about farm restructuring, and by establishing an independent restructuring advisory service to guide farms desiring to rektructure. 23. The Irigation System and Water Management. Another priority area of reform is water management. Uzbekistan needs now to begin to use less water per unit of land and use it much more efficiently. The challenge facing Government in the management of the irrigation system is to shift from a centrally-planned system that encourages excessive water use to a system that provides clear and strong incentives to use scarce water resources efficiently. Action is required in three areas: (i) introduction of water user charges; (ii) improved management of the irrigation system; and (iii) investment in rehabilitation of the irrigation infrastructure. Farms currently pay nothing for irrigation water delivered by the state. The Government has accepted the need to initiate a system of water charges and provisions have been made for its design under the Cotton Sub-sector Improvement Project. The current system for monitoring water deliveries to collective farms can be upgraded and used to start a water pricing program. The Ministry of Water Management and Melioration, through 160 water management divisions, delivers water to collective farms mostly through water "turnouts" that have functioning measuring devices that measure volume of water delivered. Ideally, the price of water should vary between regions and individual farms, to recover the costs of delivering water to each. In the near term, however, a program that imposes a single charge for water in each region may be more feasible, both practically and politically, than one that varies between farms. The Government supports the principle of instituting water charges as a means for promoting more effective water use. -9- 24. Consideration should be given to restructuring the current system for irrigation management, with the Ministry of Water Management and Melioration at the center and numerous water divisions at the local level based on political boundaries. A system based on political boundaries is incompatible with the introduction of water charges as irrigation infrastructure in one political division may actually deliver the bulk of water to beneficiaries in other political divisions. Thus, consideration needs to be given to reorganizing management of the system in a more decentralized way along hydrological boundaries. Irrigation management under such a system would involve establishment of water user associations at the farm level, water boards to manage water resources in a hydrologically defined system, and canal authorities to manage the major canal works. The whole system could be overseen by a National Water Council that would formulate and implement national water resource policies, grant surface water and groundwater rights, implement water legislation, and negotiate and implement international agreements on trans-boundary water rights. 25. Along with reorganizing the management of the system, the Government will need to initiate a program of rehabilitation and maintenance of the system to stem water losses through seepage and leakage and improve drainage. Efforts are already underway with World Bank support to identify the most pressing rehabilitation needs and to prepare investment programs. Rehabilitation of the inter-farm infrastructure would need to be accompanied by on-farm investments to improve irrigation efficiency. The introduction of water charges should provide strong incentives for such investments and post-privatization assistance to restructured farms could provide necessary financing and technical support. 26. The Role of the Government. The Government's objective to shift to a market-based economy requires a careful assessment and thorough realignment of the role of Government. The shift to the market economy requires that direct government involvement be discontinued in all aspects of input distribution, production, processing and marketing. Instead, the government should adopt a supportive, but no less important, role aimed at assuring that a competitive, market-oriented agricultural sector emerges. Key functions of the Government in a market economy include: (i) creation of a policy environment that limits market distortions, and fosters market competition; (ii) development of a regulatory structure necessary to maintain health, safety, and quality standards; and (iii) provision of basic support services which are essentially public in nature (research, extension, market information, training, water management). 27. A priority for Government should be to review the functions of the Ministry of Agriculture. A restructured and revitalized Ministry of Agriculture should remain the central institution responsible for Government's new role in the agricultural sector. It should be responsible for the regulatory framework in agriculture including food inspection, seed inspection and certification, establishment and enforcement of grades and standards, control of physio-sanitary standards, epidemiology and livestock disease control. It should also develop a capacity for policy -10- analysis and form.iulation, and for the dissemination of market information such as production and yield data, and key market price indicators to ensure that an environment conducive to competitive markets is maintained. The Government agrees with the need to realign the role of the Ministry of Agriculture along these lines. 28. Other key functions likely to remain in the public sector are agricultural research and the systems for training and for dissemination of agricultural knowledge. As with all Government support for agriculture, the research, extension and training functions have been hard hit by reduced budgets and declining public sector wage levels. Many institutions have lost as many as half of their staff, and those that remain are not clear about their mandate and have virtually no operating funds at their disposal. For research, the organization, scale, content and efficiency of current research programs need to be assessed in terms of their efficiency and relevance to the sector's needs as perceived by producers and associated agri-business. For agricultural knowledge, the focus should be on identifying the most appropriate systems and techniques for training and dissemination of information. The high rates of literacy in Uzbekistan and wide-spread access to mass media suggests that the use of multi-media approaches to dissemination of information may be cost effective. The potential for the private sector participation in providing and/or financing these services needs to be assessed. 29. Government's role in agriculture at the local level also needs to be reviewed and adapted to the emerging market-based system. Local authorities have had considerable autonomy and have intervened in the production and marketing decisions of farms and agro-enterprises under their jurisdiction. Producers can not be expected to respond to market signals if they are compelled to adhere to administrative directives from local authorities. For the Government's reforms to succeed, the role and functions of local government administrators need to be reviewed and steps need to be taken to limit their ability to influence production and marketing decisions. Such steps may need to include administrative decrees or legislation that specifically spell out the limits in the authority of local administrators to intervene in the commercial activities of producers and agro- enterprises. Impact of Reforms 30. The successful implementation of reforms aimed at transforming agriculture to a market based system will lead to dramatic changes in the sector. An agricultural system where producers and providers of agricultural services face competitive markets and where prices of both farm output and agricultural inputs are fully integrated with world market prices will likely be much different than the system currently in place. Profound shifts are likely to occur in farm incomes cropping patterns, farm structure, and the provision of agri-services. 31. Perhaps the greatest growth impact will stem from a marked improvement in the terms of trade of agriculture vis a vis other sectors. Prices of agricultural outputs and agricultural incomes, notwithstanding the effect of measures that must be taken in parallel to eliminate subsidies on agricultural inputs, can be expected to increase significantly in relation to those in other sectors of the economy and should provide a major stimulus to growth in the sector. - 11 - 32. A further stimulus to growth can be anticipated as cropping patterns are realigned to reflect the relative profitability of production at world market prices. The reforms outlined above may result in substantial changes in the relative profitability of crops. Cotton is currently heavily taxed relative to other crops, and the phase-out of state orders along with efforts now being made to improve cotton production and marketing should result in significant improvements in margins on cotton production. Cropping patterns will shift in response to these changes, although it is impossible at this point to predict with accuracy what the final outcome of these shifts will be. A key factor in the outcome will be the capacity of the market to absorb additional output without substantial changes in prices. Uzbekistan is already a major player in the world cotton market (accounting for about 20 percent of world exports), and a substantial increase in production could have an impact on world prices. Greatly expanded production of fruit and vegetables could also be attractive, provided that Uzbekistan can access international markets. Although experience with irrigated systems in market economies raises some questions about the economics of irrigated grain production, some degree of import substitution (as is currently underway) may be efficient. Government can support the process of shifting cultivation patterns by assuring that the trade regime remain open, research and extension priorities reflect emerging opportunities, and appropriate regulatory, health, and quality standards are maintained. 33. Still another stimulus to growth may be expected from the realignment of farm structures, in response to market forces, to better reflect Uzbekistan's relative factor endowments. Uzbekistan is rich in human resources but has limited water and land. Such factor endowments in other market economies and for certain cropping systems has led to smaller farm sizes. In essence, allowing for variations due to cropping patterns, individual or family owned farms tend to use their own, as well as, hired labor to cultivate smaller areas intensively. Such farms are usually more efficient at using labor intensive technologies than larger farms. Given the current structure of large collective farms in Uzbekistan, the evolution to smaller more intensive farm operations is likely to be gradual and marked by interim stages as the current system adjusts to market signals. It is important for Government to recognize this trend and to put in place policies that would promote the evolution of farm structures to more efficient forms. It is also important to recognize the critical link between price and trade liberalization and market reform on the one hand and farm restructuring on the other hand. At the time new farm units are deciding how to restructure and what to produce, the absence of competition and market reforms will reduce the returns to farm restructuring and retard its implementation. 34. The benefits of these developments can only be fully realized if resources are relatively free to move in response to the dictates of market incentives. In this regard, it is important to strike a note of caution concerning the Government's current policies and programs for shifting land and resources out of cotton production and into grain production. While such a shift may be economic, a better approach, and one that is more in concert with the transition to a market economy, would be to allow market forces to determine the cropping mix. This does not mean that Government should do nothing to assure adequate supplies of food at affordable prices. It just means that the Government needs to shift from the current production and trade based strategy to a simple trade-based strategy, leaving the production decisions to be determined on the basis of market forces. In pursuing a trade-based strategy, the Government needs to assure that no barriers to grain imports exist. - 12 - 35. While, supporting the trade-based strategy for the long-term, the Government sees the need for ensuring in the medium-term a favorable balance between domestic production and import of grain until domestic market-based trade channels have matured enough and until farmers have fully adjusted their production decision-making process and cropping patterns to fully reflect the working of market forces. 36. The developments enumerated above will have an impact on rural employment and on the incidence of poverty. Government development programs recognize the need to prevent any surge in rural-urban migration that is not the result of a real imbalance between the demand and supply of productive jobs in the rural and urban areas. To accommodate that concern, and in the absence of sufficient employment opportunities in the urban sector, Government needs to consider ways to create additional employment opportunities in rural areas to absorb any excess farm labor that may result from the restructuring and commercialization of farms. Government also needs to address the issue of how to provide for and manage the social safety net and the role the local Government should have in funding and managing it. Role of the World Bank 37. The Bank's assistance strategy for Uzbekistan recognizes the importance of an efficient and sustainable agricultural sector for restored economic growth, improved incomes and poverty alleviation in rural areas. The Bank's .role in agriculture is intended to facilitate the transition of the sector to a market-based system and includes a blend of sector-type work aimed at specific issues, adjustment lending in support of key policy reform measures, and a series of investment operations designed to address crucial constraints in the sector. For-type sector work, the intention is for the Bank to support in the context of preparation work an analysis of pressing issues that potentially could be addressed under future World Bank lending operations. Six areas of investigation are proposed: (i) rural financial intermediation possibly leading to a twinning arrangement between the Uzbek Rural Finance System and an outside agricultural credit institution; (ii) the legal and institutional framework for land reform and farm restructuring; (iii) elements of a program to stimulate competition and improved efficiency in the marketing and input supply systems; (iv) demonopolization of cotton ginning and marketing; (v) demonopolization of marketing and processing of fruits and vegetables; and (vi) development of input supply channels. 38. In the area of adjustment lending, the focus is on measures to improve the incentive structure facing producers and to foster the development of competitive trade. The Rehabilitation Loan currently under implementation emphasizes reform of the incentive structure in agriculture through measures to eliminate state orders, improvement of Government procurement of agricultural commodities, and liberalization of the trade regime. The proposed Enterprise Reform Loan is intended to support demonopolization and privatization in the wholesale trade and transport sectors, both of which are crucial to the development of alternative channels for marketing of agricultural products and for input distribution. Progress in reforming Government procurement of agricultural commodities, elimination of state orders, and trade reform will need to be monitored and, if necessary, follow-up measures will be developed in the context of the proposed Structural Adjustment Loan scheduled for FY97. - 13 - 39. The strategy for investment operations in agriculture has been discussed with Government and agreement was reached on the priority investments to which Bank support would be directed. The strategy has two main objectives. The first is to support directly the restructuring of the sector and the realignment of the role of Government in agriculture. The second objective is to address key technological constraints and rehabilitation requirements that are currently affecting agricultural productivity. The recently approved Cotton Improvement Project addresses both objectives by supporting policy reforms and institutional restructuring aimed at privatizing the seed industry for cotton and liberalizing cotton marketing. At the same time it is supporting the introduction of certified cotton seeds and an improved cotton grading system, both of which are aimed at improving cotton quality and productivity. The next four planned operations in the sector focus on restructuring. The Farm Restructuring and Development Project (FY97) will support collective farms undergoing restructuring through the provision of advisory services, and post- privatization assistance to develop basic farm infrastructure and provide necessary equipment and training. The proposed Agricultural Support Services Project (FY98) will help adapt the agricultural support services to serve the needs of a market-based agriculture. It will cover the technology development and supply system, the rural finance system, the farm information system, and the seed supply system. It will also support the strengthening of private channels for input supply, output marketing, and agro-processing. The proposed Drainage Project (FY99) is intended to tackle the pervasive problems of inadequate drainage in the irrigation system and to support policy and institutional changes aimed at improving irrigation management and sustainability. The proposed Agricultural Export Development Project (FY99S) is intended to improve the quality and productivity in the production and marketing of agricultural products with export potential, such as silk, fruits, vegetables, melons, grapes and berries. CATALOGUERS/FILE CONFIDENTIAL Report No: 15097 UZ Type: SR