Turkmenistan - Review of the Agrarian Sector

CONFIDENTIAL Report No. 15621-TM Turkmenistan: Review of the Agrarian Sector May 31, 1996 Agriculture, Industry and Finance Division Country Department III Europe and Central Asia Region Document of the World Bank CURRENCY EQUIVALENTS Until November 1, 1993 Currency Unit = Ruble 1 Ruble = 100 Kopecks After November 1, 1993 Introductory Rate Currency Unit = Manat 1 Manat = US$0.5 Manats per US Dollar November, 1993 2.0 April, 1996 3000.0 WEIGHTS AND MEASURES Metric System GOVERNMENT FISCAL YEAR January 1 - December 31 ABBREVIATIONS GDP - Gross Domestic Product CIS - Commomwealth of Independent States WTO - World Trade Organization CBT - Central Bank of Turkmenistan EUTACIS - Technical Assistance Program of the European Union for the CIS Sarian Akibo-Betts M:\BROOKS\TURKMENI\AG-REV96\TURK-TOC.DOC CO1 "TNTS E xecutive Su m m ary......................................................................................................................... I The Agricultural Sector--An Overview ............................................................................... The Natural Resource Base: Water Is the Key Constraint.......................................... Agriculture is Important for the Economy at Large and for Rural W ell-B ein g ...................................................................................................................... 3 Cotton, Grain, and Livestock Are Key Products........................................................... 5 II. The Government's Present Strategy ................................................................................... 9 Domestic Self-Sufficiency is a Key Objective................................................................. 9 The Sector is Managed Largely By Administrative Directives and Governmental Control, and Public Ownership Predominates The Organization of Decision-making........................................................................ 13 Prices and m arketing policy........................................................................................ 15 R u ral F inance ............................................................................................................... 7 Privatization and Land Reform.................................................................................. 17 III. Prospects for Agriculture in the Short and Longer Run.................................................. 19 Present Price and Trade Policies Hurt Agriculture's Prospects ................................... 19 The Current Price Policy Serves to Finance a Large Public Investment Program Undertaken by the Ministry of Agriculture and Food................................ 20 Without More Fundamental Reforms, Agriculture is likely to Decline F u rth er ............................................................................................................................ 2 1 Agriculture Will Grow with Reform, but its Share of GDP Will Decline Over Time as the Energy Sector Grows........................................................................ 23 IV. Sustainable Growth Can be Achieved Through a Comprehensive Reform Program Implemented Gradually ................................................................... 27 Macroeconomic Stabilization.................................................................................. 27 Pricing and M arketing ............................................................................................ 28 Privatization of Marketing, Processing, Input Supply, and Services ................. 29 F oreign T rade........................................................................................................... 30 Land Reform and Farm Restructuring ................................................................. 31 A gricultural Finance................................................................................................ 35 Water Policy and Pricing ........................................................................................ 37 Social Security for People with Low Incomes ....................................................... 38 V. Implementation of Recommended Reforms ...................................................................... 41 List of Figures, Tables & Boxes Figure 1.1: Turkmenistan: Population and Water Availability--Actual and Projections Table 1.1: Land Use in Turkmenistan Table 1.2: Turkmenistan: Changes in Total Area, Production, and Yields, Crop Sector Table 1.3: Five-Year Average Yield of Lint in Kg/Ha by Country from 1946 to 1995 Table 1.4: Turkmenistan--Livestock Numbers (in thousands, end of year) Table 2.1: Approximate Domestic Self-Sufficiency Ratios, Major Food Products Table 2.2: Per Capita Food Consumption in Turkmenistan, 1990-95 (kilograms) Table 2.3: Per Capita Food Consumption - Selected Middle Income Developing Countries (1986-88) kg/capita annually and calories/capita daily Table 2.4: Procurement Prices for Major Products, March 1996 Box 4.1: Farm Size in the Cotton Sector Worldwide Box 4.2: Private Agriculture on State-Owned Land in Israel Box 4.3: Water Users' Associations EXECUTIVE SUMMARY I. Reform of the agrarian sector is key to the well-being of Turkmenistan's rural people, who comprise over half (55 percent) of the rapidly growing population. Agriculture employs an estimated 44 percent of Turkmenistan's labor force, and contributes between one quarter and one third of GDP. Production of food and fiber is important now, and will remain so in the future even if earnings from energy exports recover. At present agriculture suffers from low earnings, low yields, low efficiency of water use, and problems of soil quality. The problems derive in part from current and past agricultural policies, and solutions will require changes in policy as well as investment. The problems are reflected in relatively low indicators of well-being in many rural areas; for example, low incomes and poor health of the rural population. 2. The Government's current strategy for agriculture, as articulated in programs and policies, emphasizes achieving domestic self-sufficiency in basic food staples, while maintaining cotton output. Current programs are intended to achieve growth in gross output of basic staple foods, such as wheat, meat, and milk, and to maintain production of the primary cash crop, cotton. In order to achieve these objectives, the government has encouraged expansion of production onto new areas, and farms have been directed to shift land into wheat production. Yields on virgin lands are low, and average yields have fallen since 1990. The fall in yields is sharpest in grain production, the activity for which expansion is greatest. Productivity in the livestock sector is low, but herd size is increasing while area planted to feed crops is declining. 3. Under Turkmenistan's resource constraints, agriculture must yield higher returns per hectare and per unit of water if rural people are to remain above the poverty line. Turkmenistan is a desert country with limited water and less than one hectare of irrigated arable land per rural resident. A low yielding, extensive agriculture cannot support a densely settled rural population at levels of income consistent with those in other sectors of a middle income developing country. In order for agricultural earnings to recover and grow, yields will have to increase and the commodity mix will have to shift to products that produce higher net returns per hectare. Production of high quality exportable products that generate high net returns per hectare under labor intensive technologies will have to increase. Governmental directives to keep large areas in grains and other food staples, if retained in the future, will condemn the rural sector to severe poverty. For example, at present yields of 1.6 tons per ha for irrigated wheat, agricultural producers will remain poor even if they are paid world prices for output (approximately US$200 per ton), and if they capture a large share (for example, 75 percent) of this value as returns to labor, land, and management. Net returns per hectare would be less than US$240 annually in areas where grain production predominates. Since the allocation of arable land is approximately .7 ha per rural person and falling with rural population growth, per capita incomes in areas where production of staple foods predominates would be less than US$240, and this would have to fund consumption and investment in productivity improvements. ii 4. Rural people growing grain under these conditions will be poorer than the average citizen of Turkmenistan, and very poor by international standards. Estimates of per capita income in Turkmenistan are uncertain, but current data indicate a per capita GDP of approximately US$920. Rural people will have to produce higher net returns per hectare than at present in order to reach the average GDP per capita. The human and physical resources in rural Turkmenistan are sufficient to support a higher standard of living, and higher incomes will be needed if rural people are to participate in general economic growth as the energy sector recovers. Although it is difficult to predict what products will be successful, likely candidates are high quality fruits and vegetables for export, supplemental feed for high quality pasture-based livestock, and high quality cotton. Because other crops are likely to offer higher returns per hectare, the Government should reconsider its commitment to expansion of grain production under the program "Grain." 5. Improved use of water and increased productivity of land should be the primary objectives of Turkmenistan's agrarian reform program. At present approximately 90 percent-95 percent of water utilized is used for irrigation, and the remainder for industrial and municipal uses. According to various estimates, approximately half of the water used in irrigation is wasted, in about equal proportions in transit in the main canals and in the fields. With population growth at 2.5 percent annually, demand for water for municipal and industrial use will increase, and more people will depend on earnings from irrigated agriculture. Growing pressure on limited water resources will require increased efficiency of water use and reduced losses. Work under the Aral Basin regional water management study leads to the conclusion that in the region as a whole 15 percent to 20 percent of irrigation water could be saved with better management at the farm level. Meeting these objectives will require new roles for the public and private sectors, new policies and institutions, and new interactions with the global economy. 6. A program of comprehensive reform should be undertaken to position the rural sector for income growth and to halt the current slide into severe poverty. Turkmenistan is a late-comer to agrarian reform, and almost all of the work lies ahead. Although reforms cannot be implemented over night, the consequences of delay will be severe. For example, now that aggregate credit is limited in order to reduce inflation, changes in price policy and farm finance should begin immediately to allow producers to adjust to the new conditions in the macroeconomy. Reforms should be implemented as rapidly as the new institutions needed for their success can be created. 7. Reforms should include marketing, processing, input supply, and services, as well as farm organization. A profitable agriculture requires well developed market services, such as information, processing, packaging, input supply, and financial services. Strong links with domestic and international markets are important, as are entrepreneurial initiative in marketing and ability to adopt new technologies in production. A profitable agriculture must be dynamic, adapting to frequently changing iii technological possibilities and market opportunities. Such an agricultural economy has little in common with the traditional administrative agricultural system of the Soviet era, since the latter was oriented toward quantitative production targets with little emphasis on quality, entrepreneurship, or technological dynamism. 8. Turkmenistan has the human resources to support a profitable agriculture, but lacks the institutional base and is weak in infrastructure for communications and transportation. The government at this stage should concentrate on design and implementation of reforms, on extension, dissemination of information, on agricultural research, and on rural communications and transportation to link domestic producers with internal and external markets. Government agricultural programs should facilitate adoption of higher yielding technologies of production and assist producers to shift into higher value products with good market potential, both domestically and internationally. 9. If government revenues improve with higher earnings from energy exports, there will be many opportunities for productive public investments in rural areas, such as in rural education and health, agricultural extension, agricultural research, and rural infrastructure and communications. Investments in production and marketing should be left to a private sector created through reforms. Returns to improvements in soil quality, irrigation technology in the fields, and production technology will be highest if they are undertaken by the private sector, and if the returns accrue to private owners. Privatization of land and farms will thus be an important component of a growth strategy for agriculture. Private owners farming individually or in groups will need access to competitive services for marketing, finance, and input supply. Privatization of marketing, services, and processing will therefore also be important for improved earnings in agriculture. Financial sector reforms will be needed. Since Turkmenistan is a relatively small economy, linkages with regional and global trading partners will be important. An open trading policy is therefore another needed component of agrarian reform. Changes in price policy at the producer and consumer level will be needed, along with measures to assure continued access to adequate nutrition for vulnerable consumers during the transitional period. 10. At present, the institutional and organizational structure of agriculture is still similar to that of central planning. Production is largely collective, and producers have little autonomy in decision making. The state dominates marketing and foreign trade. Agricultural finance cannot yet function on commercial terms because asset markets do not function and farm earnings are low. The private sector in agriculture plays a very minor role. In a profitable and dynamic agriculture of the future, private producers and entrepreneurs will dominate production and marketing, and the state will have to provide essential public services, such as information, extension, maintenance of infrastructure, and enforcement of standards. Creation of new institutions and functions for the public and private sectors will require a comprehensive reform of the agrarian sector. A sequence of proposed reforms is presented in summary form below, and in a matrix at the end of the report. iv 11. Macroeconomic stabilization. Reduction of inflation to low single digits under the macroeconomic goals announced for 1996 will be an important component of agricultural reform. The decision to allocate credit through the banking system by auction, rather than by presidential or governmental decree, should be retained and implemented. Interim measures to address agricultural credit needs are discussed below in paragraph 27. Interim measures should be fully reflected in the budget, and should not be allowed to compromise the macroeconomic stabilization program. The decision to initiate trading on the foreign currency auction is also an important component of macroeconomic policy, and should be implemented. 12. Pricing and marketing. State orders for meat and milk should be discontinued. Producers should have the right in 1997 to market meat and milk as they choose, either directly on rural or urban markets, or to the processing firms. This will reduce prices on direct markets and increase them in the processing channels. 13. State orders on cotton and wheat should be phased out over two years. Purchase prices on remaining state orders for these two commodities should be raised in two stages to border parity (import in the case of wheat, export in the case of cotton) at the market exchange rate. The procurement price for seed cotton in 1996 (adjusted to lint equivalent) corresponds to about 35 percent of the border price. The 1996 procurement price for wheat corresponds to 40 percent of the 1995 border price for Ukrainian wheat, and about 25 percent of the international price. The 1996 prices for cotton and wheat do not provide sufficient incentives for producers. Real producer prices for cotton and wheat under state orders should be increased administratively to border equivalent levels over a two year period, after which mandatory state procurement should be replaced by procurement under competitive tender at market prices. As procurement prices increase, producers can be expected to pay a higher share of the costs of inputs, and can begin to pay modest fees for water. Any state procurement for cotton or wheat after 1998 should be under competitive tender. 14. In the 1997 budgetary process, the budget of the Ministry of Agriculture, along with those of the other financially independent ministries, should be consolidated into one national budget. The debts of the Ministry of Agriculture should also be consolidated into the national debt, including foreign debts incurred for past investments on the part of the Ministry. Producers can thus be allowed to retain a higher value of the sales of the cotton crop, and debt obligations of the Ministry can be serviced as national debts. It is likely that new sources of funds for debt service will have to be made available, such as the reserves now held in the Foreign Exchange Fund. The change in price policy for agricultural products will have a fiscal impact, and this should best be managed in a consolidated national budget, rather than in a separate ministerial budget. The higher procurement prices can be in part self-financing if the higher prices are passed on to processors and ultimately to consumers. Measures to assist vulnerable consumers are discussed below in paragraph 38. v 15. Privatization of marketing, processing, input supply, and services. Reduction and removal of state orders will improve producer incentives only if the marketing organizations can be privatized to provide compdtitive services. In 1996 retail food stores under the former Ministry of Agriculture and Food should be prepared for privatization, and in 1997 they should be privatized. In 1996 and 1997 the six associations formerly under the Ministry of Agriculture and Food (production plus agricultural chemicals and seeds, food processing except cotton, cotton processing and trade, bread and grain products, machinery and services, capital construction), and now under the Cabinet of Ministers and the Ministry of Agriculture, should be prepared for privatization. The reorganization of the Ministry of Agriculture and Food in April, 1996 and establishment of the Ministry of Agriculture, and reassignment of the associations are positive steps toward preparation for privatization of vital agricultural services. Preparation should include splitting the associations into smaller units in order to enhance competition, design of a mechanism of privatization consistent with the general program of privatization, and provision for foreign participation where attraction of foreign capital is likely. Units that belong in the public sector, such as departments monitoring and enforcing standards for food safety and use of agricultural chemicals, should be retained within the Ministry of Agriculture. Other units should be privatized fully, and the state should not retain a majority interest. The associations should not be privatized in their present structures, since they would have few if any competitors. 16. Private and competitive firms in marketing, processing, and input supply should be functioning by the end of 1998. Although preparation of all six associations would probably take until 1998, those prepared first can be privatized ahead of the others. Because of the importance of cotton marketing, a special study should be undertaken to consider options for privatizing cotton processing and marketing, and to evaluate an appropriate role for government in a privatized industry. Cooperative ownership of ginneries is successful in some countries, and should be explored. 17. Foreign trade. At present the state maintains control of international trade by requiring that all exports pass through the Commodity Exchange. Under a reform program, agricultural producers should gain access to international markets under a liberal trading regime. Turkmenistan should begin preparation for joining the World Trade Organization by obtaining observer status and setting up a working group with the World Trade Organization. In the agricultural sector, private traders will need to be able to operate under a system of tariffs consistent with international norms, and to use or not use the Commodity Exchange as they choose. While the requirement that exporters surrender 50 percent of their hard currency earnings to the government is still in effect, the hard currency should all go through the foreign exchange auction, and non should go into the Foreign Exchange Fund. There are several possible approaches to trade liberalization, but each starts with creation of a market exchange rate through implementation of a stabilization program and active functioning of the foreing exchange auction. Unification of the exchange rate, as announced in early 1996, is an important first step. Thereafter, in 1997, there will be two basic options for trade liberalization. Under the first, imports and exports would be liberalized fully. Domestic prices would vi rise rapidly to border levels, and the impact on consumers would have to be cushioned as described below in paragraph 38. If trade were fully liberalized, the requirement that all trade pass through the Commodity Exchange would be dropped. 18. If a more gradual approach to trade liberalization is desired for key commodities, such as basic staple foods, these commodities could remain subject to the licensing requirement implicit in the mandatory trade on the Commodity Exchange. An export tax equal to half the difference between the observed domestic price and the relevant border price could be levied in order to limit the price increase in any one year. The purpose of this tax would simply be to limit the rise in domestic prices taking place in one year. The export tax would decline as the domestic price rose, and would be discontinued after three years at maximum. If the adjustment to the price change is relatively smooth and the system of social security for poor consumers is working well, the export tax could be discontinued earlier. The Commodity Exchange would thus evolve into an institution offering commercial services, like commodity exchanges elsewhere. 19. If the second, more gradual approach is chosen, it should be understood that the purpose is to implement a gradual removal of price distortions for key food commodities. The purpose is not revenue generation. Therefore cotton, other fibers, hides, and skins should not be among the commodities taxed. 20. Land reform and farm restructuring. The creation of peasant associations in 1995 presents a good starting point for privatization, since now all farm enterprises are under the same legal status. Starting in 1996 managers of the associations should be elected, rather than appointed, as at present. Land reform and farm restructuring should proceed with the objective of increasing productivity of land now in operation within the peasant associations, rather than expanding area onto additional tracts of virgin land. No new allocations of additional virgin land should be granted. 21. Many farms are now operating in part on intra-farm leasehold contracts. The leasehold contract at the household level could become a natural mechanism for gradual privatization of the land. Each farm household should have the right to take a specified area under leasehold, and to manage the leasehold either individually or in combination with other leaseholders who might have combined holdings of an entire field, for example. The leasehold should be secure and for five years, with right of purchase at the end. Livestock "fermy" can also be allocated on leasehold, with associated lands for pasture and feed. 22. During years when state orders are in effect, delivery against the state order should be considered the implicit payment for land. After state orders are phased out, small payments for land lease could be collected by the state until the five year lease expires. Leaseholders should not be subject to profile restrictions requiring them to continue traditional lines of activity or to maintain the size of the livestock herd' If the leaseholder fulfills the terms of the lease for five years, he or she should have the assured vii right to convert the leasehold to ownership by paying t price of surveying, registration, and titling. Leaseholds should be inheritable or transfe, e within the family, and tradable within the farm. Current restrictions on purcha.--; or sale of leaseholds may be retained during the five year interim period if there is strong local support for the restrictions, but land should be marketable thereafter. Experience in other countries in transition indicates that leasing markets for land become active before markets for the purchase and sale develop even where no restrictions on sales are present. Once converted to ownership, land should be fully eligible for purchase, sale, mortgage, and all usual rights of privately owned land in market economies. Land markets would thus begin to operate on a normal basis in 2001. A land law protecting rights of private owners to buy and sell land will be needed. 23. Farm members and employees should be well informed about the opportunity to take out leaseholds through an informational campaign in 1996, and the opportunity should remain open through 1998. The size of leaseholds offered to any household during the first round (1996-1998) should be limited so that land will be available to meet potential demand from all farm members. Not all farm members may choose to lease land, and they should not be required to do so. If land remains available after 1998, original leaseholders should be entitled to enlarge their holdings by trading the original small leasehold for a larger one. 24. Ownership of the non-land assets of the peasant associations should pass to the members in shares. Shareholders should have the right to keep their asset shares in the association, or to redeem them for real assets individually or in groups. Leaseholders should begin to pay fees for use of assets owned by shareholders, and the fees for service will be a source of revenues for maintenance and dividends to shareholders. 25. The Land Committee and its local affiliates should document and register leaseholds under the simple procedures now used for dacha and household plots, and issue the certificate now used for the dacha and household plots. Full titling procedures now applied to individual private farmland should be extended to leased land in 2001, after the land is converted to private ownership and when titling will become a constraint on transactions. Until 2001 full titles will not be necessary, since market transactions in land will not be legal. The Land Committee will need additional resources to document and register intrafarm leaseholds even under simple procedures. 26. It is very likely that even under full privatization of land, producers will remain in cooperative relations for management of water and production and marketing of cotton. The existing farm structure in peasant associations could evolve into a network of producer cooperatives with services provided on a cooperative or commercial basis by the farm's technical and managerial staff. Privatization of ownership and management need not lead to atomization and fragmentation of production. 27. Agriculturalfinance. The government announced in late 1995 that centralized allocation of credit by decree would be discontinued, and that credit auctions would VIii resume. This is a positive step in reform of the financial sector, and agriculture will in the long run benefit from a strengthened financial sector. Agroindustry and processing should be able to access credit on commercial terms through the banking sector. In the short run, primary agriculture is likely to be excluded from activities of the commercial banking sector until property relations in agriculture are privatized, profitability increases, and the inherited weaknesses in the agricultural bank are addressed. 28. Even in early 1996, before the impact of tighter credit constraints, formal loans through the banking system appear to be less important in financing primary agriculture than accumulated arrears. In February, 1996, primary producing enterprises of the agricultural sector held only approximately 12 percent of the 116 billion manat outstanding credit of the banking system. [All enterprises of the agro-industrial complex held a reported 36 percent share of the manat denominated credit of the banking system, but most of this is processing, procurement, and input supply.] Reported inter-enterprise arrears of farms exceeded formal lending through the banking system. Inter-enterprise arrears are not a sustainable source of financing for agricultural growth. Arrears should be settled by negotiations between and among enterprises. The government should not assume or write off debts of farms or other enterprises. 29. As an interim measure, credit for primary agriculture should be allocated directly through the budget. A minimal volume of credit needed to finance seasonal input purchases should be included in the consolidated national budget and onlent from the budget to farms through the agricultural bank on an agency basis. The agricultural bank would collect a small agency fee for distributing loans and collecting repayment, but would not engage in true financial intermediation with these funds. Accounting for the funds managed on an agency basis would be separate from the financial accounting for Daikhan Bank's other transactions, and the funds for the interim program would be partitioned from other funds of the bank. The interim program would thus not amount to yet another recapitalization of the existing system of agricultural banks, since the banks would not own the funds. The cost of the program will be transparent and included in the budgetary planning process. 30. In order to administer such a program through the national budget, the budgets of the financially independent ministries, including the Ministry of Agriculture, should be consolidated into the national budget. Without consolidation it is unlikely that revenues to manage an interim program of agricultural credit through the budget can be mobilized. 31. Although an interim program of agricultural credit will be needed in the early period of reforms of the financial sector, in the longer run producers will need viable rural financial intermediaries that offer an array of financial services, including positive real interest rates on deposits. Institutional reforms in rural finance should proceed along with design of the interim program. If inflation comes down to low levels at the end of 1996, as envisaged under the stabilization program, Daikhan Bank should ix undergo a careful audit in November 1996 in preparation for operation on a more commercial basis in 1997 and thereafter. 32. A number of options for building rural financial intermediaries could be explored in conjunction with the donor community. For example, a foreign bank could be designated as a "twin" of Daikhan Bank to offer training and guidance on management and assessment of loan applications on commercial terms. A system of rural credit cooperatives could be developed in which rural people would earn positive interest rates on their savings, and could also borrow at positive lending rates and with suitable collateral. Technical assistance for the design of the rural credit cooperatives could be requested in order to improve financial services in rural areas. 33. Water policy and pricing. Improved management of water resources will be needed if agriculture in Turkmenistan is to recover and grow on a sustainable basis. At present water is free of charge and its use is not measured. A policy to improve the efficiency of water use in Turkmenistan should include the following components: (1) an appropriate pricing policy for water in agriculture, (2) establishment of water user associations to coincide with irrigation areas, (3) water quotas awarded to producers on specific areas of land, and (4) a water law that protects the rights of users and provides for adequate mechanisms to finance the irrigation system. The implementation of these components should be integrated in the phased program for the agricultural sector. 34. Water quotas should be attached to land in units of land irrigated by one diversion from the main canal, since this is the unit of land for which water use can be metered cost effectively in the early period. Meters should be installed at these main points as soon as possible, preferably in 1996. Water charges should be introduced with the objectives of recovering a significant portion of operating and maintenance costs of the irrigation system and improving the efficiency of water use. A cost recovery scheme should be implemented gradually, and cost recovery is likely to remain partial for some time. The level of cost recovery, and thus the charges to the producers will increase in accordance with the expected increase of agricultural product prices as state orders are removed and as the economy becomes more open. 35. The proposed payment scheme would have three components: a base fee per hectare, a volumetric charge for water use within an assigned quota, and a higher volumetric charge for water use above quota. The base fee should start at zero in 1996, and increase until 2001. The volumetric fee should be zero in 1996 for the assigned quota at the farm level, and positive for quantities in excess of quota. In 1997, the per hectare charge should be positive, but small, and the volumetric fee within quota should also be positive but small. In subsequent years until 2001 the fees would increase until the desired level of cost recovery is achieved. To implement the volumetric pricing, measuring devices will have to be installed where necessary. Purchase and installation of measuring devices should take place in 1996 or early 1997. x 36. Water user associations of producers should be created to increase participation and to improve management of distribution. Key features of water users' associations are described in the body of the report in box 4.3. 37. The draft water law should provide a legal framework for the existence and activities of water user associations. The law should also provide a firm legal basis for water charges based on the principle of cost recovery, either full or partial depending on the level of agricultural earnings. 38. Social security for people with low incomes. If agriculture is to recover and contribute to growth, producer prices will have to rise, and these higher prices will be passed throughout the marketing chain, including to consumers. Measures that increase producer and consumer prices can be introduced only along with measures to assist low income consumers to adjust to the new price structure. These measures will have to be designed with consideration of wage policy within the framework of the stabilization program. 39. A poverty line derived from a food basket that meets basic nutritional requirements should be designed to identify families in need of assistance. The poverty line should reflect greater reliance on calories from fruits, vegetables, grains and dairy products than is the case in the normative food basket currently used to define the minimum necessary income. The current food basket contains 38 kilograms of meat and sausage annually, and exceeds current average consumption of these products. Low income people will be able to maintain adequate nutrition on a more modest diet. In order to have the greatest impact on nutrition of vulnerable populations, any commodity assistance, such as subsidies, should be concentrated on grains and dairy products. 40. Implementation of a program as ambitious as that described above would require major efforts of organization and financial support The World Bank can support development and implementation of a program of comprehensive agrarian reform within a broader framework of a stabilization program. A strong commitment from the Government will be needed in order to move the process forward, as well as an organizational structure to facilitate design, adoption, and implementation of reforms. A working group could be constituted at a level above the Ministerial level, perhaps under the Cabinet of Ministers, with a mandate to do analysis, design programs in the eight areas noted above (and others as necessary), draft the necessary legal documents, and present them to the appropriate legislative and/or executive authorities on a predetermined schedule. The World Bank could provide support for this process under the Institution Building Loan. Furthermore, the Bank would be prepared to consider providing loans to the agrarian sector in support of such a program. TURKMENISTAN REVIEW OF THE AGRARIAN SECTOR' L THE AGRICULTURAL SEcTOR: AN OVERIVEW 1.1 Natural Resource Base: Water is the key constraint. Turkmenistan is a desert country in which availability of water constrains agricultural production. Of the country's 49.4 million hectares of land area, 40.7 million are classified as agricultural (82 percent of the total). Much of this land, however, is desert pasture, and only 1.74 million hectares are irrigated arable lands used in intensive cultivation (Table 1. 1). The irrigated arable land amounts to only 0.38 hectares per capita, or 0.70 hectares per rural resident, making Turkmenistan's agriculture among the most intensive in the former Soviet Union. Policies that preserve and enhance the productivity of land and water are of paramount importance in Turkmenistan. Conversely, any institutional arrangements and policies that contribute to soil degradation or waste of water are very costly for the country. 1.2 Hot summers and mild winters create conditions favorable for cotton and high quality horticultural products, and multiple cropping is possible in some areas. Due to intense radiation year-round and heat in summer, evapotranspiration exceeds precipitation, as shown in Appendix Table A.2. Agriculture is thus largely dependent on irrigation, with the exception of the ecologically fragile desert pasture area. Frosts in January and occasionally in December limit winter production of horticultural products to sheltered conditions or greenhouses. 1.3 Turkmenistan's water resources derive in large part from a negotiated share of the flow of international rivers, and are presently estimated at 24.6 km3, under current agreements. Ninety to ninety-five percent of water is used in irrigation, and the remainder is used for residential and industrial uses. Major sources of water are the four international rivers: the Amu Darya, Mongrab, Tedgin, and Atrok, the most important of which is the Amu Darya. Water is further distributed within the country by the Kara Kum Canal, linking the Amu Darya and the Caspian Sea over 1,400 kilometers. This report was prepared by a team from the World Bank consisting of Karen Brooks, Ariel Dinar, and Zvi Lerman, with assistance from colleagues and organizations in Turkmenistan including: The Cabinet of Ministers, the Project Implementation Unit of the Cabinet of Ministers, the State Committee of Statistics of Turkmenistan, the Ministry of Reclamation and Water Resources, The Turkmen State Scientific (Water) Research and Project Investigative Institute, The Daikhan Bank, The State Committee on Land Use and Land Reform, the Meijlis Committee on Summary Legislation, the Ministry of Economy and Finance, the Academy of Agricultural Sciences, the Institute of Economics of Agriculture within the Agricultural Academy, the Ministry of Agriculture and Food, the Ministry of Natural Resource Use and Environmental Protection, the Central Bank, the Association of Bread Products, and the Commodity Exchange. Assistance is gratefully acknowledged. The conclusions and recommendations are those of the World Bank. 2 1.4 If current population growth rates continue at 2.5 percent annually, the amount of water available per capita in Turkmenistan will decline by one-half in the first generation after independence, as shown in Figure 1.1. Rural population is growing even faster than the national average, at a rate of 2.8 percent annually. Pressures of competing uses for limited water resources are now very great, and will intensify with continued population growth. Improved efficiency of water use is thus the key for agricultural growth and rural prosperity. Estimates of the efficiency of water use at present suggest that roughly one-half of water allocated for irrigation purposes is wasted, in roughly equal proportions in the fields and in transit in the main canals. Figure 1.1: Turkmenistan: Population and Water Availability-Actual and Projections 100001 ........... 77 -_.-.. 9000 Population (000 persons) Water Availability Index (cubic meters/person) 7000 C o 6000 go a4000 3000 2000 1000 1990 1995 2000 2005 2010 2015 2020 2025 Year Sources: For 1979 - 1995, State Committee on Statistics For 1996-2025, World Bank, Turenistan: Rationalizing the Health Sector Draft Report 1486ITM, September 1995 1.5 Because irrigated land is scarce and the ratio of land to labor is low, net returns per hectare will have to be high in the future in order to provide adequate incomes for agricultural workers. Turkmenistan's agricultural reform should therefore seek to improve yields, increase value added, improve soil quality, and increase efficiency of water use. A number of changes in agricultural technology, organization, and incentives will be needed to achieve improved management of land and water. In addition, changes will be needed in the management and pricing of water resources. These changes are urgently needed because at present the infrastructure for irrigation and drainage is deteriorating, leading to worsening problems of water quality and soil salinization. Rural households will need to invest their own labor and savings in preserving and improving 3 Table 1.1: Land Use in Turkmenistan January 1, 1995 Unit Quantity Total area 000 ha 49,403.00 Agricultural area 000 ha 40,668.50 Irrigated area 000 ha 1,744.20 of which arable 000 ha 1,659.30 of which in the state sector 000 ha 1,551.00 of which in the private sector 000 ha 108.30 Perennial crops 000 ha 84.90 of which in the state sector 000 ha 61.10 of which in the private sector 000 ha 23.80 Pasture total 000 ha 38,890.80 of which watered 000 ha 25,148.40 Irrigated arable per person ha 0.38 Irrigated area per rural person ha 0.70 Total population 000 persons 4,361.30 of which rural 000 persons 2,380.10 Source: State Committee on Land Resources and Implementation of Land Reform the quality of Turkmenistan's agricultural land. At present rural households do not have the incentives to undertake the investments, because they do not own the land. 1.6 Agriculture is important for the economy at large, and for rural well- being. Over half (approximately 55 percent) of the population is rural, and agriculture employs 44 percent of the labor force. Agriculture's share of employment has increased modestly (by 4 percent) since independence. A large proportion of agricultural workers (16 percent of total workers and 36 percent of agricultural workers) are employed on household plots. 4 1.7 Agricultural production in Turkmenistan takes place within a dual structure, consisting of large former state and collective farms, small-scale subsidiary plots of households, and a small number of newly established family farms. Until June 1995, there were approximately 350 collective farms and 150 state farms. An average collective farm employed 1000 workers on approximately 2500 ha of cultivated area, and maintained about 700 head of cattle. State farms were substantially smaller, with about 500 workers per farm, 1500 ha of cultivated area, and 500 head of cattle. State farms concentrated in sheep production and devoted a higher proportion of land to grain and feed crops than the collective sector. Collective farms emphasized production of beef, dairy, and cotton. By Presidential Decree of June 15, 1995, all state and collective farms in Turkmenistan were converted into peasant associations, with their existing membership, land and assets, and management. 1.8 Household plots accounted for 2 percent of arable land prior to 1990, but during the intervening years land in the household sector has increased to 5 percent of arable land in 1995. As noted above in paragraph 1.6, 36 percent of agricultural workers are reported to work on the 5 percent of land in the household sector. The average plot size at present is 0.25 ha. Household enterprises specialize in livestock production and horticultural products. Households produce half the meat, milk, eggs, and wool, but productivity of household livestock is reported to be low. 1.9 By the end of 1995, 3200 independent private farmers had started operations on farms averaging 25 ha each, and additional applications from 5000 potential farmers were pending. The individual private sector holds approximately 5 percent of arable land, but produces about 1 percent of gross agricultural output, in part because private farms specialize in extensive grain production, and in part because many farms have not yet brought the virgin land on which they were established fully into production. The difficulty and expense of opening new lands is very considerable. 1.10 Agricultural output in Turkmenistan in constant 1983 prices declined 16 percent between 1990 and 1994. Agriculture's share of gross social product under the old accounting procedures is reported to have been 31 percent in 1990, declining to an estimated 21 percent in 1995 under the influence of policies that reduced agricultural producer prices relative to other prices in the economy. National accounts by sector are not yet available for Turkmenistan, and if sectoral GDP data were available in domestic prices, they would undervalue agriculture's contribution to the economy due to severe price distortions. Pending fuller calculation of GDP by sector of origin, it is reasonable to estimate that agriculture at present probably contributes between one quarter and one third of Turkmenistan's GDP, if output and tradable inputs are valued at undistorted international prices. 1.11 Turkmenistan is a net exporter of fiber and net importer of food. Agricultural exports in total accounted for approximately one fifth of all exports in 1994 and 1995. Gas and oil exports, at three quarters of the total, are more important quantitatively than agricultural exports, but trade in energy is almost exclusively with partners in the former Soviet Union, with attendant problems of arrears in payment. 5 Cotton is the single most important agricultural product. Processed cotton valued at US$363 million accounted for 17 percent of total exports in 1994, and virtually all cotton exports were to countries outside the former Soviet Union. Other significant agricultural exports include cotton seed oil (US$11 million, primarily to FSU partners), fish products, and hides and skins, (largely outside the FSU). In the past Turkmenistan exported fresh and processed fruits and vegetables, but this trade was reported to be insignificant in 1994 and 1995. 1.12 Food products accounted for approximately 15 percent of total imports in 1994, and an estimated 25 percent of total imports in 1995. Major food imports include sugar, meat, dairy products, flour and grain products, alcoholic beverages, and tropical fruits. The value of food imports declined between 1992 and 1994, from US$426 million in 1992 to US$247 million in 1994. The decline in imports reflects a number of factors, important among which are disruptions in traditional trading patterns, changes in domestic demand, and the Government's program to increase domestic self-sufficiency in food. 1.13 Cotton, grain, and livestock are key products. In 1990, just prior to independence, cotton accounted for almost two thirds of the gross value of output in current prices, and just over half the value in constant 1983 prices. Crop products more generally comprised about 75 percent of the value of agricultural output in 1990, and livestock products about 25 percent. By 1994, the relative share of livestock in current prices is reported to have risen to almost 40 percent of the gross value of output, with the crop sector at about 60 percent, including 44 percent in cotton. 1.14 Changes in total area, production, and yields from 1990 through 1995 for major commodities of the crop sector are shown in Table 1.2. Grain area has more than tripled since 1990, and area under wheat has increased nine-fold. The expansion in wheat area has come in part from an increase in total planted area of about one fifth, and in part from shifts out of feed crops and cotton into wheat. Emphasis on grain production has been a priority under the Government's program intended to achieve self-sufficiency in wheat production, and farms have been instructed to shift area into wheat. 1.15 Yields of cotton lint are comparable to those of other major producers, such as the United States, China, and Mexico, as shown in Table 1.3. Although cotton yields are not low by international standards, they could be considerably higher under conditions of intensive cultivation in Turkmenistan. Yields depend on a number of factors, such as labor intensity, technology of production, and efficiency of irrigation. Yields in Turkmenistan should be considerably higher than world averages in order to provide good returns to abundant labor and scarce land and water. 6 Table 1.2: Turkmenistan: Changes in Total Area, Production, and Yields, Crop Sector Crop 1990 1991 1992 1993 1994 1995 Grain: area (000 ha) 187.30 240.00 335.20 435.20 598.00 624.00 of which wheat (000 ha) 60.00 115.00 197.00 260.00 431.00 546.50 production (000 t) 133.00 205.00 372.00 509.00 712.00 896.00 yield (t/ha) 2.22 1.78 1.88 1.96 1.64 1.63 Cotton: area (000 ha) 623.00 602.00 567.00 579.00 557.00 560.20 production (000 t) 1457.00 1433.00 1300.00 1341.00 1283.00 1304.00 yield (t/ha) 2.34 2.38 2.29 2.32 2.30 2.32 Vegetables and melons: area 40.00 36.00 28.00 19.00 24.00 20.00 (000 ha) production (000 t) 315.00 294.00 213.00 176.00 215.00 180.00 yield (t/ha) 7.90 8.30 7.30 9.30 8.80 8.80 Feed crop area (000 ha) 337.00 322.00 291.00 266.00 248.00 Orchards and vineyards: area 26.70 25.80 25.50 24.40 24.60 23.80 (000 ha) production (000 t) 169.00 167.00 125.00 114.00 133.00 171.00 Total planted area (000 ha) 1230.70 1234.60 1255.10 1324.20 1461.10 NA Table 1.3: Five-Year Average Yield of Lint in Kg/Ha by Country from 1946 to 1995 Kg/Ha 1946-50 1951-55 1956-60 1961- 1966-70 1971-75 1976-80 1981-85 1986-90 1991-95 65 USA 303.3 331.7 478.8 535.3 544.1 530.3 543.0 586.9 702.1 747.6 Brazil 149.5 194.7 187.5 217.1 242.6 249.6 257.8 247.0 300.6 369.9 China 72.4 114.6 213.2 265.1 378.2 513.4 466.7 700.8 793.9 787.2 Egypt 563.3 488.9 514.8 605.3 674.6 757.4 780.7 995.9 829.1 866.0 India 105.8 102.5 104.2 131.0 135.1 154.3 161.0 182.5 254.2 290.1 Pakistan 148.5 202.5 193.0 255.6 290.0 339.9 285.9 341.6 548.8 652.7 Mexico 299.8 351.8 474.8 580.7 701.5 801.9 919.8 922.6 1030.0 729.7 Turkmenistan NA NA NA NA NA NA NA 713.3 693.3 774.0 Other 123.8 138.2 164.7 267.9 321.7 367.0 382.1 415.7 505.7 516.3 Non USA 149.1 183.6 219.5 277.6 331.8 382.4 387.1 448.4 520.8 553.0 Total 199.6 222.2 263.7 325.2 360.1 404.2 410.2 466.7 544.0 582.1 Source: Fred E.M. Gillharn et. al., Cotton Production Prospects for the Next Decade World Bank Technical Paper Number 287, World Bank, Wash., DC, 1995. Narodnoe Khoziaistvo SSSR, various years. 1.17 Grain yields have declined approximately one third in five years to a level quite low for irrigated agriculture; 1.6 tons per hectare for wheat. A number of factors may have contributed to the decline in grain yields. Lands brought into production of wheat may be marginal lands not well suited to intensive cultivation. Irrigation techniques employed may be inappropriate for small grains, thus significantly reducing yields. Inputs and high quality seeds may be in short supply due to financial constraints at the farm level 7 and interruptions in trade. More detailed technical analysis of the grain sector undertaken by the EU 7 .CIS team in conjunction with the former Ministry of Agriculture and Food indicates tha. all of these factors contributed to depressed yields. 1.18 According to available data shown in Table 1.4, animal numbers and production of meat and milk have increased since 1990. All of the increase has come in the household and private sector: herd size and output in the enterprise sector have both declined. Data on livestock productivity are incomplete, but milk yields in the enterprise sector reportedly fell between 1990 and 1995 on average from 2,551 kilos per cow to 2,127. Yields in the household sector are reported to be approximately half yields in the enterprise sector, and the household sector now dominates dairy production. Carcass weights for cattle are reported to have fallen from 398 kg. to 320 kg. over the past five years, and calving rates from 77 to 61 per 100 cows.2 1.19 The expansion in animal numbers by about one-third and contraction of area under feed crops by one-third raises questions about the sufficiency of feed supply and trends in productivity per animal. Although data on animal productivity are incomplete, productivity is likely to fall and costs to rise if the herd size increases faster than the quantity and quality of feed available. Since the growth in numbers has taken place in the household sector, it is likely that communal pastures around villages provide much of the feed for the increased herd, and these lands may now be excessively grazed. Table 1.4: Turkmenistan-Livestock Numbers (in thousands, end of year) Animal 1990 1991 1992 1993 1994 cattle 829 899 1004 1104 1181 of which cows 331 360 416 478 534 Pigs 267 260 212 159 128 Sheep and goats 5481 5599 6265 6313 6502 Horses 19 19 21 22 25 Camels 87 93 98 101 111 Source: State Committee on Statistics, Turkmenistan 1.20 Households can be effective managers of livestock if household members have adequate access to feed supplies, markets, information, and veterinary services. If 2 O.Khodjakov, O.Annamukhamedov, and O.Soyunova, "Status and Problems of Livestock Development in Turkmenistan," paper presented at workshop on Central Asian Animal Production, February 27 -March 1, 1996, Tashkent, Uzbekistan. 8 household members do not have access to feed and services, a shift in production into the household sector is likely to result in decreased productivity, environmental degradation, and increased incidence of disease in animals and humans. The dominance of the household sector in beef and dairy production (70 percent and 80 percent of animals, respectively), and the importance of householders in sheep production (40 percent of animals) suggest that the adequacy of the feed base and veterinary services for these producers warrant attention. Moreover, the increase in the number of household animals and reduction in feed production creates strong incentives for rural households to feed subsidized bread to animals. 9 I. THE GOVERNMENT'S I ENT STRATEGY 2.1 Domestic self-sufficiency is a key objective. The program "Ten Years of Stability" adopted in 1994 calls for achievement of self sufficiency in production of grain, meat, and milk. State orders for procurement and administrative directives to increase production have been the primary instruments for implementing the policy. Data on production and consumption of meat, milk, and other key commodities allow calculation of approximate domestic self-sufficiency ratios shown in Table 2.1, although data needed for grain balances were not available at the time of this writing, and the bread product ratios are approximate. Table 2.1: Approximate Domestic Self-Sufficiency Ratios, Major Food Products* Major Food Product 1990 1991 1992 -1993 1994 1995 Bread" 0.15 0.85 Vegetables 1.67 1.54 1.23 1.00 1.30 Melons 2.15 2.30 1.56 1.38 1.78 Sugar Vegetable oil 2.54 2.54 1.91 1.82 Meat and meat products 0.70 0.75 0.72 0.67 0.70 Milk and dairy products 0.53 0.61 0.63 0.84 0.88 Eggs 1.02 1.07 0.84 0.83 0.95 Source: State Committee on Statistics * Ratio of reported domestic production per capita over reported domestic consumption per capita. **Estimate based on assumption of 800,000 tons of wheat for human consumption 2.2 The data indicate a pronounced shift toward import substitution and increased domestic self-sufficiency in food. Self-sufficiency ratios for bread and milk, traditional imports, have risen. The ratio for meat, also a traditional import, has remained about constant. Self-sufficiency ratios for the traditional exports: cottonseed oil, vegetables, and melons, have gone down. Rising ratios for imports and declining ratios for exports are consistent with a policy of import substitution in pursuit of self-sufficiency. During the period since 1990, Turkmenistan has moved from a position of primary reliance on imports of grain to near self-sufficiency. Reported wheat imports of about 150,000 tons in 1995 supplemented domestic production of almost 900,000 tons, freeing 10 some low quality wheat for animal feed, and providing improved baking qualities for bread. 2.3 Although the country is largely self-sufficient in production of wheat, shortages of bread remain serious. These shortages are due largely to retail price policy, since at very low prices consumers hoard bread and also feed it to livestock when they can get it. Increased domestic production is not sufficient to assure adequate supplies of bread if price policy is highly distorted. Growth in production and simultaneous growth in shortages is a characteristic of many highly regulated and administered economies, such as, for example, the Soviet food economy from 1965 to 1990. 2.4 Turkmenistan's exportable surplus of vegetables and melons has fallen since independence, in response to increased difficulty in reaching traditional export markets and administrative pressure to shift area into wheat. Self-sufficiency of dairy production has increased from just over half to over 85 percent. Self-sufficiency in meat has remained roughly constant at 70 percent. 2.5 Since Turkmenistan was a net food importer at the time of the break-up of the Soviet Union, and since trading relations between traditional partners have been difficult for much of the ensuing period, a moderate increase in self-sufficiency in food is a natural economic response to the changed external conditions. The unusually high prices on world grain markets in 1994 and 1995 would have accentuated the increased emphasis on domestic grain production, if domestic producers had faced international prices and been free to choose the production mix on their enterprises. Producers were not free to choose their product mix, and responded to administrative directives, rather than to economic signals. The increased self-sufficiency achieved through administrative directives probably brought higher costs than would have been the case if the economy were open to market forces, but import substitution would have taken place in the short run in any case. 2.6 Import substitution in the long run is an expensive way to assure adequate food security. Domestic production and export of products produced relatively cheaply at home in trade for products produced more inexpensively abroad can achieve adequate consumption at lower cost. Emphasis on domestic self-sufficiency will, therefore, be costly if it is retained in the future. As trading links strengthen with traditional partners and as international wheat prices decline from their current unusually high levels, the costs of domestic self-sufficiency with current yields will increase. In the longer run, additional costs will become more apparent. These will include overgrazing of pasture land to compensate for area shifted out of feed crops and into wheat, and increased competition for water used in production of food crops with low yields. 2.7 In the medium to long run, Turkmenistan's agricultural development will have to secure an adequate standard of living for those of the growing rural population who remain in agriculture. This will not be easy in a desert country where 40 percent of the labor force is agricultural. The sector will have to orient toward products that use land and water effectively and offer high value added to the labor and resources invested. 11 It is difficult to foresee what products will be successful as an economy opens and changes, but likely candidates are high quality fruits - d vegetables, high quality livestock produc.s, and high quality cotton. 2.8 Orientation toward high value crops will require a shift in thinking and decision-making away from the present preoccupation with domestic self-sufficiency in basic food staples. Wheat and milk are not high value added crops, and can be produced more cheaply in countries better endowed with water. If the sector is required by administrative measures to orient toward production of wheat, meat, and milk for the limited domestic market, incomes will fall and rural earnings will be inadequate to fund private investments needed to increase productivity. Over the longer run, food security achieved through trade under a relatively open trading regime will be less costly than domestic self-sufficiency pursued through administrative measures. 2.9 Staple foods such as wheat and milk will still be produced in Turkmenistan in an open market economy, but probably by fewer producers with much higher yields and lower costs. An average hectare of wheat uses 4,000 - 5,000 cubic meters of water and yields approximately US$320 gross value, at present yields and high international wheat prices (US$200 per ton, rather than domestic prices of US$45 per ton). Gross returns to cotton, in contrast, at present are just over US$1000 per hectare, under observed cotton yields and lint export prices of US$1700 per ton. A hectare of cotton with average yield uses 7,000 - 8,000 cubic meters of water on average. Wheat yields would probably have to triple or more in order for wheat to be a competitive crop under Turkmen conditions once the country is well integrated into world trading markets. 2.10 Yields of 4.5-5.0 tons per hectare for irrigated wheat can realistically be expected for some skilled producers with good access to high quality inputs, but average producers under administrative pressure to produce at a financial loss will not attain high yields. Reorientation toward high value instead of domestic self-sufficiency does not mean that domestic production of staple foods, such as wheat and milk will stop. Instead, producers with low costs will intensify production, and those with high costs will shift into other products. When international prices are passed fully into the domestic economy, producers will decide what to produce. Traders can place exportable surpluses on world markets and bring in imports available more cheaply outside the country. 2.11 Under a fully open trade regime, cotton may not be the only important agricultural export. With attention to quality, proper packaging, and investment in transport infrastructure, Turkmenistan could recover and develop markets for fruits, vegetables, and melons in more northerly parts of the Commonwealth of Independent States and elsewhere. Exports of hides, skins, and wool may also be viable. The balance between production for export and production for domestic markets under a fully open trading regime cannot be confidently predicted, but fears of cotton monoculture are probably not warranted. If producers have access to world markets, information, and financing for investment, and are free to choose their own production profiles, a relatively diversified sector is likely to result. 12 2.12 At this stage in the economic reform, therefore, it would be desirable to give producers power to determine their own production profiles in response to prices increasingly determined by market forces. Food security achieved through income growth and trade should replace administrative directives intended to secure domestic self- sufficiency in wheat, meat, and milk. 2.13 Although domestic self-sufficiency in food has increased since 1990, per capita consumption has declined, as is the case in all countries in transition. Trends in per capita food consumption are shown in Table 2.2. Table 2.2: Per Capita Food Consumption in Turkmenistan, 1990 - 95 (kilograms) Average for the country In rural areas 1990 1991 1992 1993 1994 1990 1991 1992 1993 1994 Bread and grain products 164 140 141 142 147 189 157 152 146 152 Vegetables 67 67 65 65 67 57 58 53 55 57 Squash and melons 40 34 35 30 28 44 37 33 30 27 Fruits and bertes 31 27 29 33 23 34 30 34 37 24 Grapes 11 10 10 10 7 14 13 16 16 9 Sugar 14 12 9 11 11 12 9 6 9 8 Vegetable oi 11 11 12 11 12 12 12 12 12 12 Meat and meat products 40 36 33 33 30 29 27 23 22 22 Fish and fish products 4 3 2 1 2 1 1 0 0 0 Mik and dety products 224 201 187 196 183 165 148 143 141 133 Eggs 87 75 86 75 64 51 51 67 51 49 Source: Survey of family budgets of 1,350 familes induding 462 collective farm families 2.14 Changes in policy could lead to an increase in demand for food in rural areas, further stimulating recovery of rural economies. Per capita consumption of livestock products is lower in rural areas than in urban areas, due largely to traditional food subsidy policies that have favored urban over rural consumers. A change in price and income policy that allowed rural people to retain a higher share of the value of their agricultural production and that removed the urban bias in food subsidy policy would stimulate production and rural demand for food. Targeted assistance should be directed to the poor in urban and rural areas. Most rural people with agricultural earnings and household production would benefit from liberalization of agricultural prices, and would not need assistance in order to maintain a nutritionally adequate diet. 13 2.15 At present food consumption appears to be on average acceptable from a nutritional perspective, and roughly comparable with that of a number of other middle income developing countries, as shown in Table 2.3. Dietary goals developed during the Soviet period have influenced Governmental policy objectives in many countries during the post-Soviet period, and have led some Governments to try to preserve and even increase consumption of livestock products, on the assumption that higher consumption is necessary and consistent with normal economic behavior. As shown in Table 2.3, when consumers in middle income developing market economies face market prices for a wide variety of goods and services, many choose a nutritionally adequate diet with low or moderate consumption of livestock products, approximately like that in Turkmenistan today. Table 2.3: Per Capita Food Consumption - Selected Middle Income Developing Countries (1986-88) kg/capita annually and calories/capita daily Columbia Costa Rica Mexico Tunisia Turkey Morocco Cereals 108.4 135.4 180.4 211.9 203.6 245.1 Starchy roots 100.5 11.7 11.0 20.4 62.7 16.3 Sweeteners 57.5 64.4 45.9 27.2 30.3 32.2 Pulses 6.5 8.6 14.7 7.7 10.4 9.9 Nuts and oilseeds 2.9 13.4 3.3 7.0 11.9 4.5 Vegetables 42.7 21.9 29.4 110.7 136.5 41.3 Fruits 91.9 85.9 87.6 87.2 161.3 48.2 Meat and offal 34.0 33.3 42.2 18.1 19.6 15.0 Eggs 6.7 4.9 9.6 6.3 4.8 3.1 Fish and seafood 3.3 5.9 9.7 10.3 6.1 10.6 Milk 82.6 143.6 109.3 77.0 64.0 33.7 Oils and fats 10.4 14.8 14.2 17.1 18.5 12.0 Vegetable 8.5 12.2 11.8 15.7 15.6 9.8 Animal 1.9 2.5 2.5 1.4 2.9 2.2 Total calories per capita 2544 2781 3123 2970 3084 2856 Source: FAO Food Balance Sheets, FAO 1991. 2.16 The sector is managed largely by administrative directives and Governmental control, and public ownership predominate& The organization of decision-making: Key decisions of agricultural policy and appointments of personnel are now presented in legally binding presidential decrees. The Medjlis, as the highest legislative body, passes laws relevant to agriculture, and these codify features of the presidential decrees with a medium to long term time horizon. The Cabinet of Ministers advises the President and the Medjlis on agricultural matters and has administrative authority in some matters of price policy and allocation of land and water rights. Fuller 14 jurisdiction over land matters rests with the committee on Land Resources and Implementation of Land Reform, an agency with Ministerial status. 2.17 The former Ministry of Agriculture and Food handled production and marketing. The Ministry was organized into six associations that operated semi- autonomously: grain and bread products; agricultural production including input supply; cotton processing; food processing; technical and machinery services; and on-farm construction and land preparation. In addition the Ministry was responsible for retail trade in food, and thus administered the food subsidy and rationing system. In April, 1996, The Ministry was reorganized as The Ministry of Agriculture with jurisdiction over the Association for Production and Technical Services and the Academy of Agricultural Sciences. The remaining associations formerly in the Ministry of Agriculture and Food were transferred to the jurisdiction of the Cabinet of Ministers. 2.18 The Ministry is one of 29 Ministries designated as "self-supporting." These ministries maintain their own budgets and accounting outside the national aggregate budget, although part of the food subsidy appears in the national budget. The "self- supporting" ministries report data to the Ministry of Economy and Finance, but accounting procedures are not transparent and the budgetary data are thus difficult to interpret. The autonomous status of the Ministry and opaque accounting procedures do not facilitate the degree of accountability needed for effective public or private institutions. Moreover, prudent fiscal management necessitates consolidation of the budgets of the "self-supporting" ministries into one comprehensive national budget. Activities of the Ministry of Agriculture that belong in the public sector, such as inspection and enforcement of standards, implementation of policy, analysis of sectoral performance and market trends, extension and dissemination of information, and other activities should be funded under a consolidated national budget. Activities in primary production, processing, and trade currently included in the costs and expenditures of the sectoral budget should be privatized. 2.19 Six Governmental ministries handle decisions in the water sector. The Ministry of Land Reclamation and Water Resources designs, constructs, maintains, and operates irrigation projects. This is the primary agency managing water allocation. The Ministry of Agriculture develops irrigation schemes on agricultural sites designated for irrigation. The Ministry of Natural Resources and Environmental Protection evaluates projects from an environmental standpoint. The Ministry of Construction participates in construction. The Ministry of Economy and Finance allocates necessary budgetary resources. The Cabinet of Ministers is responsible for the overall allocation of available water resources. There is no charge for water. A draft water law is under consideration that would provide the legal basis for introduction of charges for water use. 2.20 All foreign trade goes through the State Commodity Exchange established by Presidential decree in September 1994. The Ministry of Agriculture handles its foreign transactions through the exchange. Goods may be imported and exported without restriction or licensing requirements other than the requirement that exports pass through the State Commodity Exchange. As of January 1, 1996, foreign currency receipts from 15 agricultural trade are subject to surrender requirements of 50 percent at the market rate, 30 percent of which must be deposited with the Foreign Exchange Reserve Fund, and the remainder sold on the interbank foreign exchange auction, which is expected to become operational in 1996. The exchange rate was unified at 2400 manat per US$US in January, 1996, and adjusted to 3000 manat per USSUS in April, 1996. 2.21 Prices and marketing policy. Farms are subject to compulsory state orders for grain, cotton, meat, and milk. Local administrators are responsible for assuring that farms in their districts meet state orders. Administrators who fail to meet targets risk dismissal by Presidential decree. Farms that have met procurement targets can sell additional output either on local markets or to the procurement organizations. The levels at which state orders are set are high, however, and there is little room for production or sale in excess of the order. State orders are in effect for the entire crop of wheat and cotton, and for almost all production of meat and milk in the enterprise sector. The 1996 targets for state procurement under orders amount to 107 percent of 1995 production for cotton, and 134 percent of 1995 production for wheat. Since much of the meat and milk is produced in the household sector, the procurement targets for these products for the enterprise sector are lower relative to total production, but still comprise a high share of output of the enterprises. The meat procurement target for 1996 is about 90 percent of 1995 production in the enterprise sector. The milk procurement target for 1996 exceeds total milk production in the enterprise sector in 1995. 2.22 Other products can be marketed freely within the country, or for export through the commodity exchange. Retail prices of staple foods (bread, meat, milk, rice, and vegetable oil) are set by decree and rationing remains in effect. The price of rationed meat in January, 1996 was 100 manat per kilo, and rationed flour was 10 manat per kilo. The average monthly wage economy wide was set at manat 30,000 (about US$10) as of May 1, 1996. 2.23 Domestic prices at the farm and retail level are below international prices, indicating that a very large adjustment in prices and wages will be required as the economy opens more to international market forces. Prices for products procured under state orders are set administratively. Procurement prices are adjusted periodically, but not indexed, and their relationship to international prices therefore fluctuates with inflation. Procurement prices set in March, 1996 for the 1996 harvest are shown in Table 2.4 (in manat per ton). 2.24 At the exchange rate in April, 1996 of 3000 manat per US$US, the wheat procurement price for the 1996 crop is approximately US$45 per ton. Wheat was imported from Ukraine in 1995 at US$120 per ton, and world market prices were closer to US$200 per ton. Domestic producer prices thus appear to be less than half of the Ukrainian border prices, and less than one quarter of world trading prices on international markets. Procurement prices for livestock products fell in terms of international comparisons in 1996; for example the farm level price for cattle fell from just over US$300 per ton in 1995 to US$150 in 1996 at the exchange rate in April, 1996. This is only about 16 percent of the international trading price for beef. Cotton prices stayed 16 roughly constant in terms of international equivalents, at about 30 percent to 35 percent of world trading prices (fiber equivalent adjusted for 25 percent ginning margins). 2.25 Even though producer prices are low by international standards, consumers receive an explicit price subsidy for rationed quantities of staple foods. Retail prices are administered (for rationed quantities), regulated (for processed products sold through the state network), and free (for minimally processed items sold on local markets). Bread prices are subject to a maximum profit margin of 20 percent over costs, and flour prices are set administratively. Other prices at the farm and wholesale level are not set administratively, but processing, marketing, and foreign trade remain under the monopolistic control of the associations. Unprocessed products for local markets do not have price controls. Prices on local markets reflect supply and demand, as they did in the Soviet era. Table 2.4: Procurement Prices for Major Products, March 1996 Product Price (in manat per ton) USS Price at percent Border Price 3000 manat/US$ seed cotton 450,000 (sort 2, type 1) 150 35 percent beef (live weight) 450,000 150 16 percent sheep meat 340,000 113 16 percent pork market pricing poultry market pricing milk 71,000 24 16 percent wheat 125,000-140,000 42-47 20 percent barley 117,000 39 corn 144,000 48 25 percent rice market pricing Sources: Neitral'nyi Turkmenistan, 15 March, 1996 2.26 Rationed quantities of basic staples are available at low prices in state stores. After a fourfold increase in the price of rationed meat in December, 1995, the price was 100 manat per kilo, compared to sales on local markets at 1500 manat per kilo. All consumers can buy 8 kilograms of rationed flour per month at 10 manat per kilo (about US$0.005), a ten-fold increase over the price prior to January 1996. Increases of four-fold and 10-fold appear to be substantial increases in retail food prices, and they do represent an increase relative to wages, which roughly doubled to an average level of 20,000 manat per month. In dollar terms at the official exchange rate, however, retail prices fell in early 1996, from US$0.125 per kilo for meat to US$0.042 per kilo. Flour 17 prices fell in dollar terms by a lesser amount. Declining dollar equivalent retail prices imply that any movement toward a higher proportion of world prices for producers will require an increase in budgetary resources for food subsidy, or a shrinking quantity base for the ration program, or both. 2.27 Ruralfinance Agricultural credit is managed largely by a network of 54 Daikhan Banks, with a branch structure intended to serve all farms. Daikhan Bank was created through reorganization of the former Agroprombank, and it is among the largest banks in Turkmenistan. Data reported by the banking system as a whole indicate that in February, 1996, 36 percent of outstanding credit of the banks was for entities in the agro- industrial sector broadly defined, but only about 12 percent of bank credit appears to be held by primary agriculture; that is, farms and peasant associations. In early 1996, therefore, primary agriculture appears already to be very short of formal credit, and to rely primarily on inter-enterprise arrears for finance. 2.28 In 1996 Daikhan Bank is likely to face a contraction in the volume of credit it can on-lend to agriculture, and an increase in the cost of its funds. Interest rates in the past have been subsidized reflecting the low cost of funds transferred from the Central Bank of Turkmenistan, (CBT). The Government adopted measures in December, 1995 intended to reduce inflation in 1996 to low single digits by the end of the year, compared to monthly rates in excess of 30 percent at the end of 1995. These measures include increased autonomy for the CBT and a discontinuation of the practice of directing subsidized credit by Presidential decree. Credit auctions are to be resumed so that market forces can influence interest rates. The new policy of the CBT to rely more on credit auctions and allow interest rates to reflect market conditions will have a major impact on the agricultural sector in 1996. 2.29 Privatization and land reform. The privatization program has not yet been extended to activities within the agricultural and food sector. The small scale privatization initiated under the Law on Privatization in 1993 has included some retail trading establishments and some consumer services in rural areas, such as hairdressers and repair shops. Retail food stores the have not been privatized. Processing and procurement also remain under state ownership within the associations of the Cabinet of Ministries. Agricultural services, such as input supply and technical services, remain at present in the Ministry of Agriculture. 2.30 Approximately 90 percent of agricultural land in Turkmenistan is owned by the state. Approximately 5 percent is privately owned by private farmers, and most of this is virgin land recently brought into cultivation, or in the process of reclamation. The remaining 5 percent of land is in household plots under private household management. Households usually consider that their tenure on this land is secure, but ownership may not be documented. The Constitution of Turkmenistan, adopted in May 1992, recognizes private ownership of land by individuals (article 9), as well as corporate ownership and state ownership. Rights of private owners do not include rights of disposition. Privately owned land may not be sold, given as a gift, or exchanged. The draft land code currently under consideration confirms the right of citizens to own land privately, but restricts rights 18 of disposition to granting of temporary use rights to another party. Neither land markets nor mortgage financing could develop under the legal framework for landholding in Turkmenistan at present, or under the conditions proposed in the draft land code. The state is the sole intermediary in transfer of land holding, and valuation of land is by administrative means for purposes of taxation and setting of leasing fees. A law on land tax is currently under consideration. 2.31 Transfer of land in subsidiary household plots and gardens from the former status of inheritable possession to private ownership began under a Presidential decree of February, 1993. In addition, under this decree, citizens could apply for up to 50 ha of land in private ownership for commercial farming. The land was to be virgin land or underutilized reserve land, and a major intent of the program was to increase the area of cultivated land, rather than to transfer ownership of already cultivated area. Land granted under this program is privately owned, but transactions are strictly circumscribed. 2.32 Presidential Decree No. 1729 of March 1994, "On Restructuring of Kolkhozes, Sovkhozes, and Other Agricultural Enterprises of Turkmenistan," provided for creation of associations of peasant farms, shareholding societies and partnerships, cooperatives, associations, and other forms of enterprises out of the collective and state farms. Fifty-eight enterprises were designated for restructuring under these procedures in May, 1994, but the program was not implemented. 2.33 In June 1995, a new presidential decree abolished the existing large-scale enterprises and created in their place peasant associations. The Law on Peasant Associations (June 15, 1995) and implementing regulations issued in September spelled out the property relations and operating principles of the associations. Assets of the former enterprise have been transferred to the association in ownership. Land remains owned by the state, and allotted to the enterprise under use right. The duration of the use right is not specified, and the Government has legal authority to reallocate land by administrative procedure. The association can lease land to individuals or production groups within the farm, and has the responsibility to assure that leased land is used for its intended purpose. Membership in the peasant association is voluntary, and members may exit with household property and with the household plot, but without a share of enterprise assets or land. 2.34 By presidential decree of December 1995, associations are encouraged to lease land and assets to groups of members, with land leases of not less than ten years. Terms of the leaseholds are to vary according to whether the land is to be used for a product under state order, or for horticultural products free of orders. State orders at the enterprise level are to be passed in full down to the lease units. Under the new arrangements, the association remains responsible for input supply, machinery services, maintenance and repair, and marketing and other services. 19 III. PROSPECTS FOR AGRICULTURE IN THE SHORT AND LONG RUN 3.1 Present price and trade policies hurt agriculture's prospects. Improved performance of Turkmenistan' s agricultural sector will requite incentives for rural people to invest their labor and savings in activities that increase productivity of land and water and achieve more rational use of these scarce resources. Owners of resources will invest only if they can earn a return or profit on their investments. Returns to investment in agriculture under present pricing and trade policies are low. The economic foundation of the sector appears to be weakening, as earnings are transferred out to fund consumer subsidies and state investments in processing, light industry, and nonagricultural activities. The data on the economic state of the sector, however, allow only very cursory analysis and tentative observations. Although the farm enterprises very likely still report their accounting data in annual reports, the accounts themselves are weak and of limited use in an inflationary period. Moreover, the mission did not have access to data either on the farm level or the aggregate sectoral level that would allow rigorous analysis. A number of separate observations, however, suggest that the economic foundation of the sector is weak and declining. 3.2 Producers appear to receive about one-third of border prices for output. When producers receive less than the.international trading price for their products (adjusted for quality and transport costs), the price policy constitutes a form of indirect or implicit taxation. According to data provided for 1994, prices of major fertilizers were more expensive relative to output on domestic markets compared to world markets. On the other hand, fuel and electricity are highly subsidized and water is free of charge. In addition, farms are apparently permitted to accumulate unpaid obligations in the form of inter-enterprise arrears, and these, too, are a form of implicit subsidy. 3.3 It is likely that under present price policy, primary agriculture is both taxed and subsidized, and that, when the cost of water is excluded, the indirect taxes exceed the subsidy on balance. This conclusion is based largely on the observation that farm purchase prices are low, on reports that the quantities of subsidized inputs used are declining, and on anecdotal reports that agricultural wages are falling. If this tentative conclusion is correct, then agricultural producers would benefit from price liberalization under which producer prices went to market levels, and subsidies were removed. With higher purchase prices, farms would be able to pay higher prices for inputs and credit, and the need for Governmental subsidies would decline. Most of the gain, however, would probably come from cotton production. Yields in the grain and livestock sectors appear to be so low that it is not obvious that producers could cover costs if they paid and received world prices. The low productivity indicates that Turkmenistan's agriculture operates with relatively high real costs per unit output, and so the net taxation may not in aggregate be very large. 3.4 When the cost of delivering water is included in the analysis, it may be the case that agriculture receives more in direct and indirect subsidies than it pays in implicit taxes. Regional dimensions become relevant, since costs of irrigation at the end of the canal and at greater distance away from the canal exceed those closer to sources. Producers nearer to the canal and the source may be on balance taxed, while those at the 20 periphery and the end may be on balance subsidized. As the sector adjusts to new relative prices and as the manat appreciates with growth in energy exports, agriculture may contract from areas in which costs of delivery of water are highest. As water charges are introduced, therefore, the Government should target programs of social assistance, such as income support, training, and job creation to rural regions that are marginal in terms of agricultural production, and where agriculture may no longer be economically viable as charges for water use increase. Most of the area currently in cultivation can probably remain in agriculture even with payments for water if yields can be increased substantially. Expansion of agricultural production onto marginal virgin lands that require investment in irrigation infrastructure should not be encouraged, since these new farms may not be viable under positive fees for water. 3.5 If this tentative assessment is correct; that is, if primary agricultural production excluding the cost of irrigation is on balanced taxed, but including the cost of irrigation on balance subsidized, several conclusions follow. Price liberalization will improve agricultural incentives and contribute to recovery of production. In the short run, cotton production would probably expand. Cost recovery for irrigation must be phased in gradually, and full cost recovery may not be feasible even in the medium run. Introduction of user fees recovering a high share of irrigation costs will be possible only after yields and productivity improve considerably. Introduction of water fees is likely to affect the spatial location of agriculture, as well as the commodity mix. Improved productivity will be very important to the overall success of the reforms. Price liberalization alone will not be sufficient to put the sector on an economic foundation strong enough to carry a high proportion of the cost of irrigation. Changes in price policy should therefore be part of a package of reforms focused on increasing yields, enhancing effectiveness of water use and improving delivery, improving stewardship of the land, and assisting producers to adjust to the new conditions. 3.6 The current price policy serves to finance a large public investment program undertaken by the Ministry ofAgriculture and Food Included among the investments are imports of grain combines, flour mills, and elevators under the Governmental program "Grain," intended to achieve self-sufficiency in grain. Proceeds from cotton exports have been used to invest in textile plants and other activities to increase domestic value added in cotton. The Ministry has also invested in nonagricultural activities. 3.7 At a time when the country has as its objective the creation of a market economy, these investments should be undertaken by the private sector, and only if private agents consider them to be sound financial undertakings. The public investment program has two kinds of costs. Investments are likely to yield lower rates of return than if they were undertaken by the private sector, since the state is assuming the risk of the investments. Allocation of public funds for activities that should be in the private sector leaves fewer resources for the most productive activities of the public sector, such as education, health, and infrastructure. 3.8 Since the Ministry of Agriculture will play a very different role in a market economy than it 'as to date, it would be desirable for the Ministry not to undertake new investments in acivities that properly belong in the priva,e sector, such as primary production, processing, and marketing. Public investments in agriculture should focus on activities that will remain in the public sector, and those that enhance design and implementation of reform. These measures include areas such as information and extension, metering of water use, and investment in rural infrastructure and communications. The commitments already undertaken by the Ministry should be recognized as debt commitments of the Government of Turkmenistan as a whole and serviced as part of the general foreign debt. Funds from other sources, such as the Foreign Exchange Fund, should be used to service this debt, so that state procurement of cotton will not be necessary for debt repayment. 3.9 Without more fundamental reforms, agriculture is likely to decline further. Turkmenistan has embarked on a program of macroeconomic stabilization, but the agricultural sector is still managed by command and decree largely along traditional lines. Other countries that have brought inflation under control by tightening credit policy while agriculture remains subject to discriminatory pricing, implicit taxation, and administrative controls have found that yields decline and aggregate production falls. There are several reasons for this development. Credit ceilings of the stabilization program reduce the volume of inexpensive directed credit traditionally available to farm enterprises. Credit ceilings are also typically accompanied by efforts to stop further accumulation of inter-enterprise arrears, since the arrears cannot be monetized. Market interest rates appear high in real terms when farm purchase prices are controlled, and do not rise with the general price level. Farms borrow less and they are forced to cut back on purchase of yield enhancing inputs. Importation of new production technology becomes impossible unless the state assumes most or all of the cost, since low domestic prices and higher costs of credit make foreign inputs expensive relative to their financial return. Moreover, price distortions and controls cut farms so thoroughly off from international connections that they may not be aware of new technologies available. 3.10 As earnings of the farm enterprises fall, wages fall and farm enterprises distribute more of the wages in kind, rather than cash. Procurement and processing firms also feel the pressure of scarce credit and higher interest rates, and many cannot afford to purchase farm products and pay promptly. The practice of processing "on commission" increases, whereby farms deliver their raw materials and receive a portion of the processed product in lieu of cash payments. Farms must then either market the processed products themselves, or deliver them to employees in lieu of wages. This practice is seen in processing of products without well developed markets for export in cash, and is more likely to develop in food processing for the domestic market than in processing of fiber for export. 3.11 To the extent that farms are able to alter their commodity mix, they increase food and feed crops for internal consumption and distribution, rather than orienting toward specialized production for markets. Since farms are not equally well equipped to produce a wide array of products for internal consumption, yields decline 22 again with the trend toward generalized, rather than specialized production. More of the livestock are transferred to the household sector, but feed supplies are inadequate, and yields of meat and milk fall. Farm enterprises do not have earnings for investment, or prospects indicating that investment would have an acceptable rate of return, and the capital stock depreciates. Households have incentives to invest in their expanded household plots, but the area allocated to household production is limited, and even with investment, households cannot provide efficient feed rations from their own production. 3.12 The contraction of credit to agriculture without compensatory full liberalization of pricing, production, and marketing can lead to a rapid decline and demonetization of the agricultural sector. Governments often respond by temporarily loosening the credit controls for a special tranche of agricultural credit. The expansion of credit weakens control over inflation, and is insufficient to compensate for the retention of price and marketing controls. The outcome is often an unsatisfactory compromise in which inflation remains above targets and agricultural performance remains poor. 3.13 Many countries in transition in the former Soviet Union and, to a lesser extent, in Central and Eastern Europe, have experienced these problems when macroeconomic reforms move ahead faster than agricultural reforms. Turkmenistan has the additional problem that soil and water resources must be better managed to maintain even current yields. As the incentives and resources to cultivate fields of the large enterprises decline, soil and water productivity will also decline, contributing additionally to a decrease in production. 3.14 Continuation of current policies in agriculture in conjunction with a program of macroeconomic stabilization is likely to lead to decline of the sector. The changes in agricultural policy announced in early 1996 do not appear to be sufficient to put agriculture on a path of sustainable growth. Ten year intra-farm leaseholds do not offer security of tenure sufficient to induce households or groups of lessees to invest in land improvement and better water management. Without charges for water use, producers have little reason to conserve on water. State orders remain comprehensive for important products. Even if prices are increased substantially, farms will still need credit to purchase inputs, since they do not have retained earnings from 1995. The credit ceiling under the stabilization program and higher interest rates from the credit auction are likely to constrain purchases of inputs. 3.15 Based on the experience of other countries, there is a high likelihood that the measures announced in early 1996, will lead to a decline in agricultural output, rather than growth. Moreover, the underlying issues of improved management of soil and water are not addressed in the 1996 program. In the longer run, agriculture will decline and rural poverty will worsen unless rural people, either individually or in small groups, become owners of land and farm assets with incentives to manage them well, invest, market their output, adopt high yielding new technologies, save in local banks and credit unions, and pay taxes to support their rural communities. 23 3.16 Agriculture will grow with reform it its share of GDP will decline over time as the energy sector grows. A ,-culture's proolems in the short run are acute, and these shc.u,Id receive urgent attention . view of sectoral development in the larger run is also important, since agriculture in T;.. ioenistan will have to adjust in very fundamental ways if the energy sector begins to grow. In the medium and longer term future, agriculture's share of GDP is likely to fall, since the potential for growth in the energy sector exceeds that in agriculture. Over time, therefore, labor should be expected to leave agriculture, as opportunities open in other sectors. Growth in the energy sector and in industry is likely to exceed agricultural growth for several reasons. Constraints on water resources will limit expansion of agricultural activities more than those in other sectors. The impact of increased energy exports on the value of the manat will also reduce agricultural growth. Under favorable developments in the energy sector, earnings of foreign exchange will be large. The influx of foreign exchange will be spent in part on traded goods and services, and in part on purchase of domestic non-traded goods and services. As the foreign currency is converted into manat for purchase of domestically produced items, demand for the manat will increase and the value of the manat will appreciate. 3.17 When one sector of an economy booms, some tradable sectors become less competitive on world markets, and this can lead to a decline or reduction in growth in these nonbooming sectors.' As the manat becomes more expensive, domestically produced agricultural products will become less competitive on export markets, and foreign agricultural products will be more competitive on domestic markets. This phenomenon has been seen in many countries with growth in energy exports, such as in the Netherlands in the 1960s following the discovery of North Sea gas, and the resulting export boom in the Dutch energy sector. 3.18 A surge in earnings in an export sector, such as energy or another commodity leads to an appreciation in the value of domestic currency. The growth in export earnings can be of long duration, in which case labor and capital move out of other sectors into the growing export sector and into non-tradable goods and services. This happens because the increased demand for domestically produced goods and services raises the value of the domestic currency. Imports become less -expensive domestically and exports less attractive on world markets. 3.19 Agriculture is often one of the sectors that must adjust when a country experiences a boom in mineral or energy exports. Much agricultural output is tradable. When the domestic currency appreciates, export demand for the now more expensive food and fiber declines. At the same time, consumers shift in part to cheaper agricultural imports, and domestic demand for locally produced agricultural products declines. The result is a contraction of agriculture, and shift of labor and capital into activities that expand with the export boom, such as non-tradables and the export activity, itself. 3 For more on this issue, please see "Managing Commodity Booms-and Busts," Varangis, P., T. Akiyama, and D. Mitchell, World Bank Washington, D.C., 1995 24 3.20 Although the currency appreciation is likely to bring a contraction of agriculture, there can be off-setting benefits, as well. Imported technologies that in the past were too expensive for domestic producers to adopt may now be more economical. Part of the adjustment to the appreciation of the currency can be a dynamic search for lower costs, greater efficiency and more productive technologies. If producers can lower costs by adopting new technologies, agriculture will not contract as much, or at all. 3.21 Turkmenistan is not yet experiencing the effects of appreciation of the manat, since energy exports are still depressed, and foreign exchange earnings are not yet released into domestic financial markets. At present the manat is still depreciating sharply, from 2400 manat to the dollar in January, 1996, to 3000 manat to the dollar in April, 1996. The present depreciation of the currency hurts agriculture because prices are still fixed in nominal terms. As the manat falls, domestic producer prices also fall relative to world prices, and the purchasing power of agricultural earnings in terms of imported inputs or consumer goods falls. In the short run, fixed prices and a depreciating exchange rate hurt agriculture, and the sector will benefit from price liberalization and stabilization of the exchange rate. In the short run, therefore, monetary instability and rapid depreciation of the manat present serious problems for agriculture. 3.22 Over the longer run, when financial and product markets are functioning more normally and agriculture has recovered from the shocks of the transition period, adjustments will be needed in response to appreciation of the exchange rate. The Government's management of policy when economic growth resumes can make a difference in how agriculture and other sectors react. Commodity booms and busts can cause misallocation of investment resources, if Governments do not pursue sound policy. Prices of primary commodities often fluctuate, and commodity booms can affect the Government's budget deficit sharply. This occurs directly if the resources are owned by the public sector, as is often the case with petroleum and minerals, or indirectly, through increased export and import taxes and higher income tax revenues. The boost in revenues sometimes encourages Governments to commit to long-term and expensive programs and projects that may not be based on sound economic criteria. When commodity prices decline, so do Government revenues, but not expenditures. As a result, countries can be worse off than before the boom. This will be the case in particular if the investments undertaken during the boom have lower returns than expected. 3.23 In the post-oil boom Nigeria of the 1970s and early 1980s, for example, the shortfall of revenues was so severe that external borrowing had risen dramatically even before oil prices began to fall. Mexico's and Venezuela's handling of oil booms resulted in much the same outcome; i.e., over-commitment of expenditures and increased foreign indebtedness. Poor management of trade policy can worsen the problems caused by a commodity boom. Trade restrictions limiting imports can lead to further appreciation of the exchange rate, since even more purchasing power is directed toward the domestic market. In Kenya after the 1976-79 coffee boom, import and capital controls increased profits of suppliers of capital goods and imported consumer goods so much that the gain 25 from the boom went largely to urban dwellers who supplied these goods, rather than to the farmers who produced the coffee. 3.24 Governments have taken various measures to avoid the negative effects of Dutch disease. They have adopted prudent fiscal policies (limiting expenditures to realistic expectations of revenues), liberalized import restrictions and removed capital controls, tightened monetary policies, and reduced foreign debt. When the increased earnings from the exported commodity are likely to persist over a long period of time, the high growth in the booming sector will necessitate changes of a more permanent nature in other sectors. The Government's share of earnings from the exports can appropriately be used to facilitate adjustment in other sectors. 3.25 Rural people in Turkmenistan will have to adjust in the longer run to the new balance in the economy, and this adjustment will have many dimensions. Yields and productivity in agriculture will have to increase if the sector is to remain competitive as the manat appreciates. The education and health of rural people will have to increase so that they become more productive. Rural people will need more skills to stay productively in agriculture and to move out of agriculture as opportunities open elsewhere in the economy. Rural roads and telecommunications will need to be modernized so that rural people are better linked to the national and international economies. The linkage is needed so that information can flow more cheaply into rural areas, and so that products, inputs, and people can flow in and out at lower cost. 3.26 The need for adjustment in rural areas will create many opportunities for appropriate and productive public investment as the Government's revenues from energy exports increase. Rural education, health, and infrastructure for transport and telecommunications should have high priority for public funding. Agricultural research and extension services can also offer a high return to public investments, since the private sector is likely to invest too little in these activities. In contrast, investments in primary agricultural production, on-farm land reclamation and irrigation technology, and processing of food and fiber are best undertaken by the private sector. Government revenues should not be used for these purposes. International experience has shown that agricultural producers, like other economic agents, choose farm investment activities more carefully and assure that they are more productive if their own private money is risked than if the state carries the cost of investment. 3.27 Successful development of export opportunities in the energy sector can provide funds for a prudent and highly productive program of public investment in rural areas, and this public investment will assist the agricultural sector's adjustment to changes in the national economy over time. Since the needs for public investment in rural education, health, roads, and communications in Turkmenistan are so great, public investment should concentrate in these areas. Investment in primary production and processing should be left to the private sector. 26 3.28 Even though the relative share of primary agriculture will fall over time if the energy sector grows according to its potential, agricultural production can still grow in absolute terms. Returns to labor, land and capital in agriculture can grow if productivity increases. Returns at present are very low, as reflected in low yields, and the potential for improvement is great. The declining share of agriculture simply means that agriculture will grow less rapidly than the rest of the economy. 3.29 Agriculture will remain an important sector, and, in fact, the importance of attention to agriculture and rural areas will increase. Agriculture's importance will increase because the well-being of the entire country will depend on how well the adjustments in the rural sector are managed. A country in which a small segment of the urban population benefits from energy earnings while rural people sink into deeper poverty is not likely to be stable or to provide the level of confidence necessary to attract foreign investment into the energy sector. Sustainable growth in the energy sector and in the economy at large is therefore more likely to be achievable if agricultural reforms can be pursued successfully without undue delay. Moreover, it is very important that agricultural reforms be well underway before earnings in the energy sector rise significantly. Agriculture will need organizations and policies that allow the sector to adjust to changes elsewhere in the economy. Failure to provide the organizations and policies in other parts of the world has resulted in widespread flight of rural people to urban slums, with resulting additional problems of poverty, crime, and social unrest. 27 IV. SUSTAINABLE GROWTH CAN BE ACHIEVED THROUGH A COMPREHENSIVE REFORM PROGRAM IMPLEMENTED GRADUALLY 4.1 Sustainable growth in agriculture in Turkmenistan is most likely to be achieved through a program of comprehensive agricultural reform implemented gradually. Since Turkmenistan is late in starting agricultural reforms, but is already committed to macroeconomic stabilization, agricultural reforms should proceed without delay and as rapidly as the necessary institutional structure can be created. A successful reform program would fully liberalize production and marketing decisions, transfer ownership of land and farm assets to rural households and small groups of producers, create private and competitive agricultural services in processing, marketing, and input supply, and establish institutions through which producers can learn about new, higher yielding, environmentally sustainable technologies and finance their adoption. 4.2 If further measures of comprehensive reform can be adopted, the outlook for the sector is good. Producers with secure ownership of their assets and access to world market prices will invest in land improvement and better water management. Higher earnings from world market prices for export products will make it possible to buy high quality inputs that can increase yields very substantially. Gradual introduction of fees for water use with partial cost recovery will encourage more rational use of water. 4.3 A reform program should contain the following components: 4.4 Macroeconomic stabilization. Reduction of inflation to low single digits under the macroeconomic goals announced for 1996 will be an important component of agricultural reform. Inflation harms agriculture in many ways. Earnings from one season lose value before they can buy the next season's inputs. Uncertainty about prices creates difficulty in planning production and investment for the future. An unstable exchange rate impedes introduction of new technology when key components must be imported. Stabilization will therefore improve the outlook for agriculture. 4.5 In the early period of the stabilization program, agricultural credit will require particular attention and special procedures described below, since Daikhan Bank is not likely to be in a strong position to compete for funds on a credit auction. In all countries in transition agricultural banks have had great difficulty adapting to market- determined interest rates and commercial banking practices. This is because they are specialized institutions with concentrated portfolios, and they hold large quantities of bad debt. Moreover, their traditional clients are in general not creditworthy under normal banking procedures, since incomes are depressed by official price policy, and farms do not own collateral in land. While these institutional problems in rural finance are addressed, special procedures will have to be devised to give farms access to needed production credits. Suggested special procedures are described below in paragraphs 4.30-4.33. Interim measures to address agricultural credit needs should be fully reflected in the budget, and should not be allowed to compromise the macroeconomic stabilization program. 28 4.6 Pricing and marketing. State orders for meat and milk should be discontinued. Producers should have the right in 1997 to market meat and milk as they choose, either directly on rural or urban markets, or to the processing firms. This would reduce prices on direct markets and increase them in the processing channels. Meat and dairy processors should simultaneously be prepared for privatization in 1997 and privatized in 1998, through a general program of privatization. Preparation for privatization should include breaking up regional processing monopolies by grouping plants in at least several separate firms that can compete with each other. This should reduce the likelihood that monopolistic behavior on the part of processors will depress producer prices even after formal price controls are lifted. 4.7 State orders on cotton and wheat should be phased out over two years. Purchase prices on remaining state orders for these two commodities should be raised in two stages to border parity (import in the case of wheat, export in the case of cotton) at the market exchange rate. Complex calculations linking purchase prices to costs of production will not be necessary once the exchange rate is unified and more stable. The purchase price for 1997 can instead be set at a specified percentage of the import or export price (adjusted to the farm level for quality and transport costs) at the time of delivery, and raised to border parity over the two year period. 4.8 Cotton processing, marketing, and storage in the US, where these services are offered on a competitive basis, absorb between 25 percent to 35 percent of the export value of a ton of fiber, depending on the level of world prices in a given year. On average, producers in Turkmenistan in a fully competitive economy might expect to receive 70 percent of the export price of lint. The objective of the reform could be to attain this level in the third year, by consecutive increases in procurement prices, reduction in state orders, and full liberalization in 1999. In March, 1996, Central Asian cotton was offered at Liverpool for US$1760 per ton c.i.f., or about US$1700 adjusted back to the Turkmen border. Subtracting 30 percent for processing and adjusting back to the seed cotton equivalent yields a farm level price of US$400 per ton of seed cotton under reasonably competitive conditions after liberalization in 1999. The difference between the current procurement price of US$150 per ton and the market price should be made up by increments in the procurement price in 1997 and 1998, and reductions in the volume of state orders. Thus even in 1997 a portion of cotton can be sold at a price determined by markets, as they begin to function on a small scale. The difference between the farm level price for wheat of US$45 and the international price, currently around US$200 per ton, should also be made up in two steps through administrative adjustments in price in 1997 and 1998, and reductions in the volume of procurement. Any state procurement for cotton or wheat after 1998 would be under competitive tender. 4.9 Payment of higher procurement prices for cotton and wheat will necessitate a full recalculation of the Ministry of Agriculture's budget. As noted above, the Ministry's budget should in 1997 be consolidated into the national budget. The impact of simultaneous reduction in producer subsidies and increase in producer prices should be calculated, so that the net impact on the budget can be evaluated. 29 4.10 Through administrative increases in procurement prices and reduction in the amount of state orders over the proposed program, producer prices will increase significantly but gradually. The increase will come in part because prices for state orders will increase, and in part because a larger proportion of oitpuit will be sold directly, outside of state orders. The objective of this component of reform is to increase incentives for growth in production and to increase producers' incomes, thereby stimulating private investment. 4.11 Consumer prices for bread, meat, vegetable oil, and milk will increase, and additional budgetary resources will be needed to assist low income consumers to adjust to the higher prices. Measures to protect low income consumers while controlling the budgetary costs of consumer subsidies are discussed below in paragraphs 4.404.43. 4.12 Prvatization of marketing, processing, input supply, and services. Reduction and removal of state orders will improve producer incentives only if the marketing organizations can be simultaneously privatized to provide competitive services. Price reforms thus require institutional changes in the sphere of marketing in order to be effective. Experience in other countries in transition has shown that price reforms and land reform do not succeed if marketing remains in the hands of state-owned or parastatal monopolies. For example, Russia has had a program of land reform in place since 1991, but few eligible people have chosen to become private farmers because they do not have access to competitive markets for products, inputs, and credit. Although Russia has privatized a substantial portion of agricultural marketing, the firms are not competitive, and markets remain highly regulated and segmented. In Hungary, on the other hand, input marketing and much of food processing was liberalized and privatized early in the reform, and the markets function well. Turkmenistan lags far behind most countries in transition in privatization of processing, marketing, and supply of inputs and services. Creation of competitive internal markets in Turkmenistan will take some time, and preparations should be started early. 4.13 In 1996 retail food stores under the Ministry of Agriculture should be prepared for privatization, and in 1997 they should be privatized. In 1996 and 1997 the six associations under the Ministry of Agriculture (production plus agricultural chemicals and seeds, food processing except cotton, cotton processing and trade, bread and grain products, machinery and services, capital construction) should be prepared for privatization. Preparation will include determination of the units in which privatization will take place (in order to enhance competition), design of a mechanism of privatization consistent with the general program of privatization, and provision for foreign participation where attraction of foreign capital is likely. Preparation should also include restructuring of the assets of each association into smaller constituent enterprises that, when privatized, will not constitute territorial or functional monopolies. For example, several firms can be created to provide machinery services and provision of agricultural chemicals to farms in territories that overlap. Units that belong in the public sector, such as departments monitoring and enforcing standards for food safety and use of agricultural chemicals, should be retained within the Ministry. Other units should be privatized fully, and the state should not retain a majority interest. The associations should not be 30 privatized in their present structures, since they would have few if any competitors. Entry of new firms will be as important, or perhaps more important, as privatization of existing entities. The commercial code should be reviewed to assure that it does not create barriers to establishment of new private businesses. 4.14 Although preparation of all six associations would probably take until 1998, those prepared first can be privatized ahead of the others. Privatization of the first associations could probably begin in 1997. The objective of this component of the program should be to have private and competitive firms in marketing, processing, and input supply functioning by the end of 1998. Because of the importance of cotton marketing and because cotton raises some special issues with regard to managing volatility of world prices, a special study should be undertaken to consider options for privatizing cotton processing and marketing, and to evaluate an appropriate role for Government in a privatized industry. 4.15 Foreign trade. At present foreign trade is highly regulated in order to keep domestic consumer prices low, to prevent exports to neighboring countries where prices are higher, and to generate earnings to support an ambitious program of centralized public investment. The main instrument of regulation is the requirement that all trade pass through the Commodity Exchange. Under a reform program, agricultural producers should gain access to international markets under a liberal trading regime. Producers should be linked to world markets, including those of the CIS, either directly or through trading intermediaries that buy and sell products on competitive domestic markets. These linkages are needed so that producers have maximum incentives to introduce high yielding technology and produce efficiently. 4.16 The extreme distortions between domestic and international prices raise difficult questions about how to achieve the beneficial effects of more open trade without creating excessive shock during the adjustment period. There are several possible approaches to trade liberalization, but each starts with creation of a stable exchange rate through implementation of a stabilization program. Unification of the exchange rate, as announced in early 1996, is an important first step. In addition, Turkmenistan should prepare to join the World Trade Organization by applying for observer status. When this status is granted, a working group will be set up to consider further measures of trade reform. When the exchange rate is more stable and more truly reflects demand for the manat than at present, the relation between domestic and foreign prices will be easier to see than it is now. At that point, in .1997, there will be two basic options for trade liberalization. Under the first, imports and exports would be liberalized fully. Domestic prices would rise rapidly to border levels, and the impact on consumers would have to be cushioned as described below. The budgetary implications of this would have to be worked out in design of the stabilization program, but it is difficult to do so now, since the level of the exchange rate later in the year is uncertain. If trade were fully liberalized, the requirement that all trade pass through the commodity exchange should be dropped. 4.17 If a more gradual approach to trade liberalization is desired for key commodities, such as basic staple foods, these commodities could remain subject to the 31 licensing requirement implicit in the mandatory trade on the Commodity Exchange. An export tax equ- to half the difference between the observed domestic price and the relevant borde :,rice could be levied in order to limit the price increase in any one year. The export tax would decline as the domestic price rose, and would be discontinued after three years at maximum. If the adjustment to the price change is relatively smooth and the system of social security for poor consumers is working well, the export tax could be discontinued earlier. This second approach has the disadvantage that it introduces a new instrument of regulation, but the Commodity Exchange is already designed to administer such an instrument. If some other mechanism for collecting the tax is available, the Commodity Exchange need not serve that function. The requirement that all trade pass through the Commodity Exchange would be dropped for all but a specified number of commodities, for which it would be retained for three years at maximum. The Commodity Exchange would thus evolve into an institution offering commercial services, like commodity exchanges elsewhere. 4.18 If the second, more gradual approach is chosen, it should be understood that the purpose is to implement a gradual removal of price distortions for key food commodities. The purpose is not revenue generation. Therefore cotton, other fibers, hides, and skins should not be among the commodities taxed. Domestic prices for cotton would increase immediately to the domestic equivalent of export prices, and the portion of output procured under state orders at administered prices in 1997 and 1998 would constitute a tax on producers that would be transparent and visible. During the interim period while exporters are still required to surrender 50 percent of their hard currency earnings, all of the surrendered earnings should be placed on the currency auction, and none should go into the Foreign Exchange Fund. 4.19 Although trade liberalization raises difficult problems of adjustment, opening the Turkmen agricultural economy will bring many more gains than losses. International trade generates income, through improved productivity in production, and through improved opportunities for marketing. A most striking example of the impact of trade on agricultural productivity can be seen in the East German experience after unification with West Germany. Grain yields in East Germany prior to unification were roughly two-thirds those of Western Germany. Unification created a fully open trading regime, by combining the two economies into one. By 1994 yields in the East exceeded those in the West, even though unification brought a decline in agricultural producer prices by about one half. The increase in yields in such a short time came because Eastern producers had full access to any technology available on the Western market, and, in addition, had generous adjustment payments that made it possible to purchase or finance new technology. In the case of Turkmenistan, a fully liberal trade regime would have a lesser impact than in the German case, but the increase in productivity would still be substantial. Liberal trade would improve earnings of agricultural producers and improve access to higher yielding inputs. If producers have secure rights to land and increasing freedom to market outside of state orders, they will invest in higher yielding technologies. 4.20 Land reform and farm restructuring. The creation of peasant associations in 1995 presents a good starting point for privatization, since now all farm 32 enterprises are under the same legal status. In 1996 managers of the associations should be elected, rather than appointed, as at present. Many farms are now operating in part on intra-farm leasehold contracts. The leasehold contract at the household level could become a natural mechanism for gradual privatization of the land. Each farm household should have the right to take a specified area under leasehold, and to manage the leasehold either individually or in combination with other leaseholders who might have combined holdings of an entire field, for example. The leasehold should be for five years, with right of purchase at the end. Livestock "fermy" can also be allocated on leasehold, with associated lands for pasture and feed. 4.21 During years when state orders are in effect, delivery against the state order should be considered the implicit payment for land. After state orders are phased out, small payments for land lease could be collected until the five year lease expires. The phasing out of state orders will have an important impact on the success of leasing and privatization of land; leaseholders and owners must be free to make managerial decisions regarding their assets. Leaseholders should not be subject to profile restrictions requiring them to continue traditional lines of activity or maintain the size of the livestock herd. If the leaseholder fulfills the terms of the lease for five years, he or she should be able to convert the leasehold to ownership by paying the price of surveying, registration, and titling. Leaseholds should be inheritable or transferable within the family, and tradable within the farm. Once converted to ownership, land should be fully eligible for purchase, sale, mortgage, and all usual rights of privately owned land in market economies. 4.22 Land markets would thus begin to operate on a normal basis in 2001. By that time many of the distortions in the current economic environment would be removed, and the financial system should be functioning on a stronger basis. Land owners must have the right to mortgage and sell land, since investment in land leveling and improvement will be needed to increase efficiency of water use and to raise yields. If land owners cannot be sure that they will be able to recover the value of this investment, they will not be willing to invest. The state will not have the resources to invest in improvement of private land, nor should it do so. 4.23 Farm members and employees should be informed about the opportunity to take out leaseholds in 1996, and the opportunity should remain open through 1998. The size of leaseholds offered to any household during the first round (1996-1998) should be limited so that land will be available to meet potential demand from all farm members. Not all farm members may choose to lease land, and they should not be required to do so. If land remains available after 1998, original leaseholders should be entitled to enlarge their holdings by trading the original small leasehold for a larger one. 4.24 The Land Committee and its local affiliates should document and register leaseholds under the simple procedures now used for dacha and household plots, and issue the certificate now used for the dacha and household plots. Full titling procedures now applied to individual private farmland should be extended to leased land in 2001, after the land is converted to private ownership and when titling will become a constraint on 33 transactions. Thei. -id Committee will need additional resources to document and register intrafarm l.,seholds even under simple procedures. 4.25 It is very likely that even under full privatization of land, producers will remain in cooperative relations for management of water and production and marketing of cotton (Box 4.1). 4.26 The existing farm structure in peasant associations could evolve well into a network of producer cooperatives with services provided on a cooperative or commercial basis by the farm technical and managerial staff. Privatization of ownership and management need not lead to atomization and fragmentation of production. The producer cooperatives would be voluntary, and members would be free to exit while retaining ownership of their land and other assets. If producers left a production or marketing cooperative, they would still be bound by joint obligations for water management outlined below in paragraphs 4.34-4.39. 4.27 The leaseholds described above differ significantly from the intrafarm leasing currently in practice in Turkmenistan. The current leasing relations and those proposed under the Governmental program for 1996 are for units larger than the household or small group, usually at the team or brigade level. Although the recommended period of the lease under the current program is ten years, the leasehold does not provide security of tenure, nor does it offer ownership at the expiration of the lease. Because of the size of the brigade and lack of security of tenure, individual members will not be willing to invest their own savings in land improvement. Experience in China has shown that households are unwilling to make substantial investments in leased land when they do not have security of tenure. On less desirable marginal lands in China, in contrast, where households have secure and documented long term tenure, private investment is significant. Under this curious situation in China, less productive marginal land under secure 50 year leasehold attracts investment even though the return is lower than the potential return to investment in prime land. The better land held on five and ten year leaseholds does not attract private household investment because families do not feel that their tenure is secure. 34 Box 4.1: Farm Size in the Cotton Sector Worldwide Cotton is produced on farms with size varying from large scale mechanized estates to small holder family farms. Large scale producers enjoy many advantages and generally achieve higher yields because mechanization and chemical weed control enable them to carry out field operations in a timely fashion. In some countries they are aided by advanced technology used to interpret data on insect pest populations, weather, and plant development, aiding farmers in making managerial decisions on spraying, irrigation, and fertilizer applications. Large scale producers enjoy advantages in marketing. Based on 580 kg/ha lint yield (approximately 1700 kg/ha seed cotton, the current world average) 37 ha of land produce a 100 bale contract. Large scale producers in the USA and Australia are able to contract most of their crop before planting. It would take 75 to 150 smallholders with farms of one quarter to one half ha to produce a 100 bale contract. Thus, smallholders who join together for marketing can realize some advantages of forward contracting in market economies. Smallholders have advantages where labor costs are low and where quality differentials are reflected in price differentials. Smallholders combining family labor with access to machinery services and advisory services can achieve many advantages of large-scale production, while still utilizing available labor. Some of these advantages can be attained by consolidating plots owned by smallholders into one production unit within an association or cooperative. Farmers share equipment and plant the crop during a restricted period, which has advantages for pest control. In francophone African countries, Greece, and Israel, cooperatives of individual producers play an important role in providing smallholders with advantages of large scale production and marketing of cotton. Source: Fred E.M. Gillham et. al., Cotton Production Prospects for the Next Decade World Bank Technical Paper Number 287, World Bank, Wash., DC, 1995. 4.28 It is desirable, therefore, to increase the security of land tenure in Turkmenistan by converting leaseholds into ownership at the end of five years. Leaseholds should be held at the household level, because it is households that generate savings for investment. Leaseholders may choose to manage their lands jointly, or may manage them individually, but agree on a given crop rotation and purchase inputs and machinery services jointly. Whether land is managed individually or jointly, it is desirable that the specific plot of land corresponding to a household's share be identified. Even if several leaseholders choose to manage their land jointly, private investment is likely to be greater if the household rather than the brigade is the leaseholder, and if security of tenure is high. 4.29 If the leasehold is not converted to ownership, the next best approach would be to allocate the leasehold at the household level, and make it a long term tradable leasehold of 99 years. Although agriculture in most countries with market economies is based on private ownership of land, there are examples, such as the State of Israel, in which successful private agriculture has been established on land leased under long term 35 leasehold fronr - state. Features of the organizational structure of Israeli agriculture are presented in E .2. 4.30 tgriculturalfinance. The Government announced in late. - 995 that centralized ali -tion of credit by decree would be discontinued, and that credit auctions would resume. This is a positive step in reform of the financial sector, and agriculture will in the long run benefit from a strengthened financial sector. In the short run the cessation of centralized credit for agriculture in practice means that agriculture will be largely cut off from credit unless alternative interim arrangements are made. It is neither appropriate nor productive to cut off agricultural credit during the period of reforms in the financial sector. As an interim measure, therefore, agricultural credit should be included in the consolidated national budget and onlent from the budget to farms through the agricultural bank on an agency basis. The agricultural bank would collect a small agency fee for distributing loans and collecting repayment, but would not engage in true financial intermediation with these funds. Accounting for the funds managed on an agency basis would be separate from the financial accounting for Daikhan Banks' other transactions, and the funds for the interim program would be partitioned from other funds of the Banks. The interim program would thus not amount to yet another recapitalization of the existing system of agricultural banks, since the banks would not own the funds. The banks would serve only as agents for funds owned by the budget. The size of the program of budgeted agricultural credit will be limited by the availability of funds and the likelihood of repayment. Estimates of the cost of the program will be transparent and included in the budgetary planning process. 4.31 In order to administer such a program through the national budget, the budgets of the "cost accounting" ministries, including the Ministry of Agriculture should be consolidated into the national budget. Without consolidation, it is unlikely that revenues to manage an interim program of agricultural credit through the budget can be mobilized. Criteria for allocation and terms of repayment should be defined during design of the program. Because of the overall constraint on the budget, credit allocated through the interim program will be limited largely to production credit for purchase of seasonal inputs. 4.32 Although an interim program of agricultural credit will be needed in the early period of reforms of the financial sector, in the longer run producers will need viable rural financial intermediaries that offer an array of financial services, including positive real interest rates on deposits. Institutional reforms in rural finance should proceed along with design of the interim program. If inflation comes down to low levels at the end of 1996, as envisaged under the stabilization program, Daikhan Bank should in November 1996 undergo a careful audit in preparation for operation on a more commercial basis in 1997 and thereafter. Strengthening of the institutions of rural finance should be a focus of the first two years of the reform program, while the interim program is still in existence. After that period the need for credit provided through the budget should diminish, and the activity of genuine rural financial intermediaries should accelerate. 36 Box 4.2: Private Agriculture on State-Owned Land in Israel More than 80 percent of Israeli agricultural output derives from two kinds of producers' cooperatives, the kibbutzim and the moshavim. In the kibbutzim all production decisions are made collectively. Land is held by the village community, all equipment is owned collectively, and democratically elected managers are responsible for all aspects of economic activity. Individual members of kibbutzim do not have household plots for subsidiary production. The average land holdings of a kibbutz are 800 ha, leased in perpetuity from the state. Consumption decisions are made collectively, and all needs of each family are provided by the community. In a moshav, on the other hand, plots of land are assigned to individual households, and all production decisions are made by the family. A moshav is a voluntarily constituted and democratically run association of individual producers supported by a local service cooperative. There are on average about 80 households in a moshav. The average plot in a moshav is 5-6 ha, leased for 49 or 99 years from the state. Households own the farm structures on their plots (greenhouses, livestock barns, dairy parlors), and also have some farm machinery, but usually on a limited scale. Moshav members are thus individual, private producers cultivating their own farms. For all farm services they rely on a village-level service cooperative that buys and stores farm inputs, markets the members' products, maintains a machinery pool and workshops for joint use by the members, provides bookkeeping and collection services, etc. Traditionally one of the most important functions of the moshav association has been to finance working capital for its member farms. The village cooperative is responsible for maintaining municipal services in the moshav community. The kibbutzim and moshavim are served by a secondary level of regional service cooperatives, the members of which are kibbutzim and moshavim, rather than individual producers. The regional cooperatives provide a variety of services to their members, including processing, storage, marketing, consultant services, and financial intermediation. Israeli cooperatives went through a serious financial crisis in the last decade. The anti- inflationary Government policy in 1986 dramatically raised real interest rates and eliminated agriculture's traditional access to generous and highly subsidized credit. The burden of inherited debt became crushing when credit restrictions were imposed. Some moshavim and kibbutzim disintegrated and some regional cooperatives were liquidated. As a result of the crisis and measures to address it, kibbutzim and moshavim are changing and reorganizing, shifting toward greater personal (rather than cooperative) responsibility for finances, and emphasizing profitability, diversifying, and learning to live with hard budget constraints. Now that virtually every rural household has a telephone and car, the earlier importance of cooperative provision of communication and transport, particularly for marketing purposes, has faded somewhat. The kibbutzim and moshavim are thus evolving into different structures, and into organizations providing different services than in the past. 4.33 A number of options for building rural financial intermediaries could be explored in conjunction with the donor community. For example, a foreign bank could be designated as a "twin" of Daikhan Bank to offer training and guidance on management and assessment of loan applications on commercial terms. A system of rural credit 37 cooperatives could be designed in which rural people would earn positive interest rates on their savings, and could also borrow at positive lending rates and with suitable collateral. Savings of rural households will be an increasingly important source of financing for working capital as incomes recover and as centralized credits decline in volume. Rural households will need savings instruments with positive real rates of interest in order to buy inputs for production on their leaseholds. Technical assistance for the design of the rural credit cooperatives could be requested in order to improve financial services in rural areas. 4.34 Water policy and pricing. Improved management of water resources will be needed if agriculture in Turkmenistan is to recover and grow on a sustainable basis. At present water is free of charge and its use is not measured. A policy to improve the efficiency of water use in Turkmenistan should include the following components: (1) an appropriate pricing policy for water in agriculture, (2) establishment of water user associations to coincide with irrigation areas, (3) water quotas awarded to producers on specific areas of land, and (4) a water law that protects the rights of users and provides for adequate mechanisms of financing of the irrigation system. The implementation of these components should be integrated in the phased program for the agricultural sector. 4.35 Water quotas should be attached to land in units of land irrigated by one diversion from the main canal, since this is the unit of land for which water use can be metered cost effectively in the early period. These "water use areas" may be the size of existing peasant associations, or smaller, depending on the present irrigation system. An initial allocation of the quota can be based on the current amount delivered to the user area. Water user associations should be formed by producers working lands in this area, both leaseholders and private producers. The association should manage and allocate the quota among the producers, and inform the Kara Kum Canal operators on future water delivery schedules. 4.36 Water charges should be introduced with the objectives of eventually recovering a significant portion of operating and maintenance costs of the irrigation system and improving the efficiency of water use. A cost recovery scheme should be implemented gradually, and full recovery of operating and maintenance costs should not be expected in the early period, while yields are still low. The level of cost recovery, and thus the charges to the producers will increase in accordance with the expected increase of agricultural product prices as state orders are removed and as the economy becomes more open. 4.37 The proposed payment scheme would have three components: a base fee per hectare, a volumetric charge for water use within an assigned quota, and a higher volumetric charge for water use above quota. The base fee should start at zero in 1996, and increase until 2001. The volumetric fee should be zero in 1996 for the assigned quota at the farm level, and positive for quantities in excess of quota. In 1997, the per hectare charge should be positive, but small, and the volumetric fee within quota should also be positive but small. In subsequent years until 2001 the fees would increase until the desired level of cost recovery is achieved. To implement the volumetric pricing, measuring devices will have to be installed where necessary. Purchase and installation of measuring 38 devices should take place in 1996 or early 1997. The proceeds from the water charges should be used entirely to finance operation of the irrigation system, and should not go to the general budget. 4.38 Water user associations of producers should be created to increase participation and to improve management of distribution. Every producer (leaseholder or owner) should have to belong to the water user association serving his or her area of irrigation. The water user association will be responsible, among other things, for managing the water supply at the secondary canals, monitoring its use, providing necessary water-related information to producers, collecting fees and water charges, planning short- and long-term investment projects at the association level, and resolving water-related disputes between producers within the association. Key features of water users' associations are presented in Box 4.3. 4.39 The draft water law should provide a legal framework for the existence and activities of water user associations. The law should also provide a firm legal basis for water charges based on the principle of partial or full cost recovery. 4.40 Social security for people with low incomes. If agriculture is to recover and contribute to growth, producer prices will have to rise, and these higher prices will be passed throughout the marketing chain, including to consumers. Measures that increase producer and consumer prices can be introduced only along with measures to assist low income consumers to adjust to the new price structure. These measures will have to be designed with consideration of wage policy within the framework of the stabilization program. 4.41 If agricultural producer prices rise under the reform program and if producers are free to choose their production profiles, fewer rural households will be poor. There will still be a need to identify and assist poor rural families, but most of the assistance can be targeted to low income urban families. A poverty line derived from a food basket that meets basic nutritional requirements should be designed to identify families in need of assistance. Since the average monthly wage comes to less than US$10 at the new exchange rate, prices that reflect even 50 percent of border prices for tradable staple foods will create hardship for urban families that do not produce much of their own food. Consumption patterns in urban areas are likely to change, with increased consumption of fruits, vegetables, vegetable oil, and grain, and lower consumption of meat. The poverty line should be derived from a food basket providing adequate nutrition with a greater reliance on calories from fruits, vegetables, grains and dairy products than is the case in the normative food basket currently used to define the minimum necessary income. The current food basket contains 38 kilograms of meat and sausage annually, and exceeds current average consumption of these products. Low income people will be able 39 Box 4.3: Water Users' Associations Irrigation development policy in many countries has undergone a dramatic shift over the past five years. Emphasis on the state as the central actor in developing and managing irrigation systems is being replaced by a search for local users' organizations able to take on a greater role. Various types of these organizations are functioning in more than forty countries on all continents. Water users' associations provide an organizational structure in which producers sharing a common water source can exchange information, jointly manage distribution of the water, and collect payments for services and to maintain local infrastructure and equipment. Water users join associations in order to improve maintenance and to improve delivery of water, thereby increasing yields. The value of membership must exceed the additional costs that members assume by joining. If water is free of charge and not metered, producers have little incentive to improve delivery of water, even if higher yields could be achieved. When water is metered and volumetric fees are paid, producers have good incentives to economize on water use, improve the timeliness of delivery, and increase yields in order to cover the higher costs. Mexico has recently made major changes in water policy and in the management of irrigation. The Mexican program features a public-private partnership with new roles for the users and the National Water Commission, the Government agency concerned with management of water resources. Full or partial management responsibility for more than 55 irrigation districts with an area of 2.5 million ha has been transferred to water users' associations. The associations manage irrigation subsystems varying in area from 5,000 to 20,000 ha. The associations are responsible for operation and maintenance of secondary irrigation and drainage systems. Elected leaders of the associations negotiate water management issues and rehabilitation needs with the National Commission's managers at the district level. In some cases a user organization at the district level undertakes operation and maintenance of the main irrigation system. A number of changes in policy and law have been put in place to support these reforms in Mexico. A new National Water Law has been passed that gives legal recognition to the users' associations. The National Commission and the users' associations sign a concession agreement that specifies their mutual responsibilities. Members and participants are trained to understand and fulfill their new roles. The associations have a system of charging for irrigation services and mobilizing resources for maintenance. The Government of Mexico has launched an on-farm development initiative to enhance farm level productivity and water conservation, as well as a program to register and assign water rights to users. The Mexican reforms are being assisted by international organizations, including the Food and Agricultural Organization, the Inter-American Development Bank, and the World Bank. It is too early to assess the sustainability of the Mexican program and its impact on resource use and productivity in the long run, although its short-term impact has been positive. In an early survey of participants, 80 percent of respondents in four irrigation districts indicated that irrigation services had improved. Source: Ruth Memzin-Dick et. al., "Sustainable Water User Associations: Lessons From a Literature Review," Agriculture and Natural Resources Department, The World Bank and International Food Policy Research Institute, 1994; Cecilia Gorriz et. al., "Irrigation Management Transfer in Mexico," World Bank Technical Paper No. 292, The World Bank, Wash., DC, 1995 40 to maintain adequate nutrition on a more modest diet. Assistance should be targeted to consumers genuinely at risk of failing to attain a minimally adequate diet, rather than a normative average diet. 4.42 In order to have the greatest impact on nutrition of vulnerable populations, any commodity assistance, such as subsidies, should be concentrated on grains and dairy products. Prices of other staple foods should move to market clearing levels and the quantity base for the rationing system should be reduced. Actual assistance can be in the form of commodities, cash, or food stamps. International experience indicates that there is some advantage to direct distribution of commodities to women in needy households, since this method of intervention results most directly in improved nutrition of women and children, who are usually the most vulnerable to nutritional deficit. 4.43 The bread subsidy should be replaced by a flour subsidy during the interim period until a program of targeted cash assistance or commodity distribution can be introduced. Many poor families buy flour and bake their own bread. Subsidizing flour instead of bread reaches more of the poor families. Projected subsidies for meat in 1996 should be reconsidered, and the quantity base for the subsidy should be much reduced. Some of the meat subsidy should be transferred to milk. 41 V. IMPLEMENTATION OF RECOMMENDED REFORMS 5.1 Implementation of a program as ambitious as that described above would require major efforts of organization and financial support. The World Bank can support development and implementation of a program of comprehensive agricultural reform within a broader framework of a stabilization program. Specialists working within Turkmenistan have already developed a broad range of proposals for reform and much of the analytical work needed to evaluate the impacts of alternative proposals. The country is not lacking in analytical capacity, but the work done is not well integrated into formulation of policy. As a consequence, the reform process is still at an early stage, and much remains to be done. In order for the process to move ahead, the Government will have to show strong commitment to a comprehensive program of reform in the agrarian sector, and create an organizational structure facilitating design, adoption, and implementation. 5.2 Because agrarian reform in Turkmenistan is broader than agriculture in the narrow sense, and because the Ministry of Agriculture will itself be undergoing major change in the course of reform, it is unlikely that the Ministry will be in a position to lead and guide the process, although it will certainly play an important role. A working group could be constituted at a level above the Ministerial level, perhaps under the Cabinet of Ministers, with a mandate to do analysis, design programs in the eight areas noted above (and others as necessary), draft the necessary legal documents, and present them to the appropriate legislative and/or executive authorities on a predetermined schedule. The World Bank could provide support for this process under the Institution Building Loan. Furthermore, the Bank can consider providing loans to the agrarian sector in support of such a program. Proposed Sequence of Agrarian Reforms, Turkmenistan Macroeconomic policy Pricing and Privatization of marketing, Social Safety Nd marketing input supply, services 1996 Prepare for consolidation Design mechanism for Evaluate need. of Ministerial budget privatization of agro- Identify target population. into national budget. industry and services. Stop meat subsidy, retain Meet targets for Begin preparation of six flour and milk subsidy. reduction of inflation. Associations. Initiate credit auction. 1997 Implement fiscal No mandatory state Privatize retail food stores. Introduce cash payments consolidation. orders for meat and Continue preparation of for target population. Keep inflation low single milk. Limited Associations for Reduce ration base. digits. government privatization. procurement by Study options for privatizing tender. cotton processing and Cut state orders on marketing. cotton and wheat by Begin privatization of 1/3. Procurement Associations. price at 60% border price. 1998 Maintain sound fiscal No mandatory state Complete preparation of Switch to cash payments. and monetary policy. orders on meat and remaining Associations. milk. Complete privatization of Cut state orders on Associations. wheat and cotton by Implement recommendations additional 1/3. of cotton study. Procurement price at 80% border price. 1999 Maintain sound fiscal No state orders. Assess performance of Monitor maternal and and monetary policy. Any state procurement privatized providers of child nutrition, plus takes place at services. selected elderly. competitive tender. Monitor prices and margins. Revise program as Identify constraints to needed. competition, if any. 2000 Maintain sound fiscal No state orders. Assess performance of Monitor maternal and and monetary policy. Any state procurement privatized providers of child nutrition, plus takes place at services. selected elderly competitive tender. Monitor prices and margins. finance. Identify constraints to competition, if any. 2001 Maintain sound fiscal No state orders. Assess performance of Monitor maternal and and monetary policy. Any state procurement privatized providers of child nutrition, plus takes place at services. selected elderly. competitive tender. Monitor prices and margins. Identify constraints to competition, if any. Foreign Trade Land Reform and Farm Agricultural Finance Water Policy and Pricing Restructuring 1996 Unify exchange Elections for farm managers. Design program in Pass water law establishing rate. Design land reform program interim finance for legal basis for pricing and Activate auction for based on intra-fann inclusion in 1997 water users' associations. determination of household lease. budget. Install metering devices at exchange rate. Do not open new virgin land Audit of Daikhan Bank. main diversions. at government expense. Announce program. 1997 Either: Education to inform people. Implement program of Begin pricing of water. Liberalize fully, or Determine size and location interim finance. Form water users' Impose export tax of of lease holds. Twin Daikhan Bank with associations. half the Begin initial distribution of foreign bank. Train members of difference leaseholds and shares. Design system of rural associations. between market Register leaseholds. credit cooperatives. price and border Introduce lease payments for price for staple producers except for tradable foods. cotton and wheat. Modify draft land law. 1998 Either Finish first round of Interim finance. Raise water charges. Maintain liberal distribution. Twin Daikhan Bank. Extension advice on water trade regime; or Notify participants if Create rural credit use. Reduce export tax additional land available. cooperatives. Training and oversight for by half. Monitor implementation associations. Begin preparation to Continue registration of enter WTO. shares. Pass land law sanctioning private ownership and market transactions. 1999 Full liberalization. Begin collection of lease Reduce size of interim Raise water charges. Continue payments for producers of credit program. Continue training and preparation to cotton and wheat. Consider linking credit education. enter WTO. coops in network. 2000 Full liberalization. Pass legislation supporting Stop interim credit Raise water charges. Continue land transactions. program. preparation to Evaluate rural financial enter WTO. institutions. Review legal foundation for mortgage. 2001 Full liberalization. Convert leaseholds to No intervention. Raise water charges. Continue ownership. Monitor early experience Evaluate level of cost preparation to Begin registration and with mortgage finance. recovery. enter WTO. titling. Land markets function. IBRD 27371 KAZAKHSTAN UZBEKJSTAN AZERBAUAN TURKMENISTAN .r . *-~* *. Ashgabat ISIAIC REPUBUC OF IRAN AFGHANISTAN SEPTEMBER 1995 CATALOGUERS/FILE CONFIDENTIAL Report No: 15621 TM Type: SR