Uzbekistan - Country assistance strategy

Dokx=t of The World Bank FOR OMCLAL USE ONLY Report No14019-UZ MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANRK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS 0ONA COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF UZBEKISTAN MARCH 3, 1995 Country Department III Europe and Central Asia Region This document has a restricted distibution and may be used by redpients only in the performanc of thdir official duies. Its contents may not otherwie be diosed without World Bank authorzattion.  Abbreviations CAS Country Assistance Strategy CBU Central Bank of Uzbekistan CG Consultative Group EBRD European Bank for Reconstruction and Development EDI Economic Development Institute ESW Economic and Sector Work EU European Union FSU Former Soviet Union GDP Gross Domestic Product IDF Institutional Development Fund IFC International Finance Corporation IMF International Monetary Fund LPG Liquified Petroleum Gas MIGA Multilateral Investment Guarantee Authority SOE State Owned Enterprises SPC State Privatization Committee STF Systemic Transformation Facility VAT Value Added Tax FISCAL YEAR January 1-December 31  FOR OFFICIAL USE ONLY UZBEKISTAN: COUNTRY ASSISTANCE STRATEGY Table of Contents A. Background .............................. 1 B. Recent Economic Developments .............................. 2 Macroeconomic Performance ..................... ..... .2 Status of Structural and Sectoral Refonns ..................... 3 C. Economic Prospects and External Environment ...................... 5 Macroeconomic Prospects .............................. 5 Balance of Payments Prospects ........................... 6 Creditworthiness .................................... 8 D. Country Development Objectives and Policies ...................... 10 Macroeconomic Stabilization ............................ 10 Structural Reforms .................................. 11 Sectoral Reforms ................................... 13 Poverty Alleviation ................ 16 The Social Safety Net ................ 16 E. Bank Group Assistance Strategy ........................... 17 Objectives ........................... 17 Past Bank Assistance ............................ 17 Proposed FY96-98 Lending Program: A Graduated Response Strategy . . 18 Sectoral Composition of the Investment Program ..... ........... 20 Economic and Sector Work (ESW) ........ ................ 23 Capacity Building .................................. 24 Aid Coordination and Resource Mobilization .................. 24 Role of the IMF and Other International Institutions .... .......... 25 Negative Pledge Waiver . .............................. 25 Risks ...................................... 25 F. Agenda for Board Consideration .............................. 26 Text Tables: 1. Key Indicators . ......................................... 6 2. External Financing Requirements and Sources (1994-1998) and Bank Exposure Indicators ................................ 9 3. Key Scenarios .......................................... 21 |This document has a restriced distribution and may be used by recpients only in the performance of their lofW duties. Its contents maynotothewisebdisclosedw thoutWorld Bank authorization.  - 11 - Annex: 1. Program Priorities and Goals ................................ 27 2. Bank Group Fact Sheet ................................. 28 3. Status of IFC Investments ................................. 29 4 Technical Annex .................................. 30 i. National Accounts . ........................... 31 ii. Balance of Payments ............................ 32 iii. External Capital and Debt ........................... 33-34 iv. External Trade ............................ 35 v. External Financing Requirements ......................... 36 vi Key Indicators, Intermediate and High Case ..... ............. 37  MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF UZBEKISTAN A. BACKGROUND' / 1. Uzbekistan lies in the heart of Central Asia, situated between two rivers, the Amu Darya and Syr Darya. It shares its borders with four Central Asian nations, Afghanistan and the Aral Sea. Twenty two million people, over 70 percent ethnic Uzbek, occupy the country's 447,200 km2. Despite its substantial resources, per capita gross domestic product (GDP) was estimated at only US$860 in 1992. Uzbekistan became a member of the World Bank and the IMF in September 1992. In October 1993, the Bank approved a US$21 million Institution Building Technical Assistance Loan to assist the Government in the formulation and implementation of its reform strategy. This CAS is the first Country Assistance Strategy prepared for Uzbekistan. 2. The country has a diversified base of natural resources, including oil, lead, zinc, wolfram, coal, silver and copper, and is the world's seventh largest producer of gold. It is also among the world's ten largest natural gas producers. Although most of the natural gas is currently exploited for domestic consumption; there is some potential for natural gas exports. Similarly, the recent discovery of two new oil fields enhances medium-term production prospects. In 1992, industrial production, primarily raw materials processing and agricultural machinery and input production, accounted for about 40 percent of GDP, while agricultural production represented about one third. Uzbekistan is the world's fourth largest producer and third largest exporter of cotton, the mainstay of the agriculture sector. The country has suffered considerable environmental degradation stemming, in large part, from improper agricultural chemical use coupled with excessive irrigation. 3. Following its independence in August 1991 and entry into the Commonwealth of Independent States in December 1991, direct presidential elections were held in which President Islam Karimov, the former first Secretary of the Communist Party was elected. A new Constitution was promulgated in December 1992 which endorses the principles of state secularism, multi-party systems, freedom of expression and observance of human rights. The Constitution further provided for the establishment of a new, smaller (150 member) legislature, the Oly Majlis, which was elected in late December 1994. The political structure has remained highly centralized, however, and the ruling People's Democratic Party (formerly the Communist Party), has remained dominant. For administrative purposes, the country is divided into 12 regions (oblasts) and one autonomous republic. t Mm Country Economic Memorandum, 'Uzbekismn - An Agenda for Economic Reforms,- (Report No. 11683-UZ; September 8, 1993) provides a detailed description of the country's sectoDi and structural chracteristics. Also see Uzbekistan Economic Memorandum: Subsidies and Transfers- (Report No. 12934-UZ; June 20, 1994).  -2 - B. RECENT ECONOMIC DEVELOPMENTS 4. Uzbekistan's initial approach to economic reform was very cautious. Although it partially liberalized prices, privatized most small shops and residential housing and enacted preliminary banking, property and foreign investment legislation, the Government retained control of most economic activities. The deterioration of the economic situation and the withdrawal from the ruble zone in late 1993 prompted the Authorities to consider a more comprehensive set of reforms. On January 22, 1994, a Presidential Decree was issued which called for broader reforms, including acceleration of privatization and enterprise reform; development of the private sector; reduction of the state orders; and liberalization of foreign exchange controls. Along with the appointment of reformers to key policy-making positions, recent policy measures, including unification of the exchange rate; reduction in consumer subsidies; and an increase in interest rates, confirm the Government's shift toward implementing a more substantive reform program. In mid-November 1994, the Government reached agreement with the International Monetary Fund (IMF) on a Systemic Transformation Facility (STF) program, which was approved by the IMF in January 1995. Macroeconomic Performance 5. After the breakup of the Soviet Union, Uzbekistan faced difficulties common to the FSU republics: production inefficiencies; the breakdown of the inter-republican trade and payments mechanism; highly monopolistic market structures; increasing budget deficits and distorted price and incentive systems. Measured by the GDP deflator, inflation rates averaged 915 percent in 1993, compared to 700 percent in 1992. Domestic credit to enterprises increased drastically, interest rates remained highly negative in real terms and the budgetary deficit rose to about 12 percent of GDP in 1993. A substantial part of the fiscal deficit was due to large budgetary transfers to enterprises and direct consumer subsidies. These subsidies amounted to around 9 percent of GDP, mostly for bread and flour, sugar and vegetable oil. Residential gas, heating, electricity and public transportation were also heavily subsidized. 6. Despite the unstable macroeconomic situation, the overall cumulative decline in Uzbekistan's real GDP during 1992-1994 was significantly less than for other FSU countries -around 15 percent compared to an average of 40 percent. Disruptions in the availability of imports particularly hampered manufactured output, which fell by over 15 percent in 1993 and declined further in 1994. The largest drop occurred in the heavy industrial sector, which was most closely linked to other FSU republics, with whom trade and payments were disrupted. By contrast, agriculture expanded moderately during 1993-1994. Domestic oil and gas production also expanded significantly over the last two years. The fact that Uzbekistan kept its centralized system relatively intact for the first two years after independence and postponed adjustment has been cited as a factor in moderating decline. In fact, it was mainly Uzbekistan's ability to diversify export markets away from FSU trade and growing oil and gas production that contributed to cushion output contraction. 7. On November 15, 1993, Uzbekistan left the ruble zone and introduced an interim currency - the sum-coupon. Despite Government efforts to maintain an unrealistic official exchange rate, the free market rate of the sum-coupon depreciated rapidly. In the first months of 1994, inflation accelerated and the Government slowly started to shift away from expansionary fiscal and monetary policy. As a result, the 1994 overall budget deficit was below 4 percent. The improvement in the 1994 fiscal position resulted from the Government's decision to eliminate the enterprise sector's access to special budgetary transfers and, to a lesser extent, to curtail direct budgetary consumer  -3 - subsidies. The Central Bank discount rate was increased to 225 percent on October 1, 1994 and a three month fLxed term deposit was introduced in the Savings Bank, with a quarterly interest rate of 30 percent. Inflation at the retail price level, which had persisted at a monthly rate of over 20 percent in the first half of 1994, fell dramatically to a monthly average of 2 percent during July- September 1994, partly reflecting seasonal factors and a good harvest. 8. Along with reducing the fiscal deficit and curtailing monetary expansion, the Government introduced an interbank foreign exchange auction on April 15, 1994. After the national currency - the sum - was introduced on July 1, 1994, progress was also made in institutionalizing weekly auctions of foreign exchange - although the volumes now traded in the auctions are still limited. A dual exchange rate system was temporarily established in August 1994 and unified in October 1994. Status of Structural and Sectoral Reforms 9. Enterprise Reforn/Privatization. State-owned enterprises have continued to burden the country's financial resources through their links with the budget and the banking system. Furthermore, ownership and governance structures are not in place to impose accountability and financial discipline. The Government's program for enterprise reform has evolved in two stages as the Government has enacted new legislation, created new institutions and implemented structural reforms to underpin the process. Stage 1, initiated in 1992 and completed in October 1994, concentrated on small-scale privatization, retail shops, trade and service objects', and housing. Private sector development, however, remained stunted since substantial institutional and regulatory barriers discouraged the emergence of competitive markets. Access to credit, land, utilities, permits and licenses remained impeded by bureaucratic interventions and obstacles. Under Stage I, there was little reform in medium and large enterprise governance. Management was appointed by associations, holding companies or line ministries themselves without regard to market-based performance criteria. Enterprise reporting was based on quantitative outputs, rather than on return to capital or other measures of market performance. 10. Aware of these deficiencies, in early March 1994 the Government initiated Stage II with new measures designed to expand privatization and to introduce increased competition and openness in the transfer processes. This program of privatization was accompanied by some 40 pieces of legislation and administrative acts. To date, over 96 percent of the housing has been privatized and approximately 82 percent of the privatization of the targeted small-scale objects has begun.' However, the privatization program had many shortcomings. Almost all of the privatization of small- scale entities was through direct transfer or sale to staff. Very limited numbers of small-scale enterprises were sold to the public through auctions. The corporatization of 600 medium scale and 400 large scale enterprises was done in closed stock form with the Govermment generally continuing to hold the majority share. The Government has recognized the need to deepen the privatization program, especially by reducing the combined state/collective ownership of shares (paras. 37-38). 'I- All privatizaton program figures refer to 'objects" which may include one or more enterprises. For simplicity, this text uses .objects' and 'enterprises interchangeably. 3/ 7The total number of enterprises has been estimtted at 18,717. Of dis, 6952 enterprises (schools, hospitals, security installations etc.) have been exempted from privatizaion. This privatization process was initated for 9,634 of the remaining 11,765 enterprises subject to privatization through end-1994. The 1995 tauets envisage approximately 1,189 of the renaining 2,131 enterprises would be privauzed by end-year.  -4- 11. Financial Sector. Uzbekistan's banking structure followed the specialized and segmented Soviet model. Three large national sectoral banks were responsible for transactions in agriculture, industry and foreign trade. Following independence, the Central Bank of Uzbekistan (CBU) approved the creation of 22 new banks, including a bank to support non-state owned enterprises, three private banks, and a joint venture bank. The new banks compete freely for household deposits, which no longer have to be transferred by the savings bank, Uzsberbank, to the CBU. On April 1, 1994, all of CBU's cash operations were transferred to the newly-created commercial banks, to fulfill the principles of a two-tier banking system. In late 1994, the CBU was allowed to retain 30 percent of foreign exchange receipts surrendered by enterprises and organizations, regardless of form of ownership. As of November 1994, the CBU and the authorized commercial banks ensure that foreign exchange is available at currency exchange offices to allow customers to exchange sums into foreign currency on an regular basis. 12. Agriculture. In the past Uzbekistan's agricultural sector was characterized by low yields, high input use and spoilage, and large distortions caused by price controls, the state order system and input subsidies. In the first years following independence, the Government kept the state order system intact. This was particularly significant for cotton, since the high implicit tax on farmers through the state orders was used to finance large consumer subsidies particularly on energy. Initially, reforms moved slowly, but beginning in 1993-1994 a number of important changes were initiated. Along with broad price liberalization and reform of the foreign exchange regime, the Government started to phase out the state order system. By end 1994 most industrial state orders and state orders for all agricultural commodities except cotton and grain were eliminated. In 1993 state orders on cotton and grain were reduced from 80 and 75 percent, respectively, and in 1994 to 67 percent for both commodities. However, procurement prices for cotton are currently only 12-15 percent, and for grain 25-30 percent, respectively, of the world price. Net taxation of agriculture through the state order system is now estimated at $1 billion annually, most of it representing a tax on cotton. State purchases, outside of agriculture, are limited to petrol, diesel, coal and a small number of consumer items, such as salt and vegetable oil for distribution in hospitals, schools and special shops. The Government has increased land available for private farming from 1.5 million ha. to 2.5 million ha. and has been transferring state and livestock farms into collective, cooperative and leased forms of ownership. 13. Energy. Uzbekistan has significant petroleum resources. Oil production doubled between 1980 and 1990 and again increased from 2.8 to 3.3 tons per year between 1990 and 1992. However, as a result of its geographic location and past inclusion in the FSU, Uzbekistan depends on Russia and the rest of the Central Asian Republics for transport services. Owing to the extreme difficulties in exporting petroleum to the world markets, to date foreign investment in the oil sub-sector has been limited. Furthermore, price distortions still exist in all energy products and services, with implicit subsidies for petroleum and large cross subsidies between the industrial and household sectors for gas and electricity. Some progress was made in 1994 with substantial price increases reducing the implicit subsidies and the relative difference between the price for residential and industrial consumers. 14. Social Protection. Uzbekistan inherited a system of social protection from the FSU featuring broad-based child allowances, old age pensions, disability benefits and high subsidies on consumer goods and services. In early 1994, the Government announced a shift toward a more targeted system of social protection. However, social transfers and subsidies remained large - about 19 percent of GDP including the relatively high cost of pensions, which were about 11 percent of GDP in 1994.  -5- Subsidies on consumer goods have been curtailed and now apply only to bread and flour. Although prices of these three items remain administered, they were sharply raised in September 1994 and were adjusted upwards again in November 1994. Furthermore, a system of benefits and services for the unemployed was established in 1993 and a new Pension Law was adopted in May 1994. The system of family allowances has been rationalized to a single benefit linked to the minimum wage, and a flat monthly compensation of 150 sum, adopted for the adult population to avoid wage and pension indexation on the eve of price liberalization, which would have imposed a much larger fiscal burden. C. ECONOMIC PROSPECTS AND EXTERNAL ENVIRONMENT Macroeconomic Prospects 15. In a situation where the Government is implementing its economic reform program consistent with a high case policy scenario, output declines would be steepest in the manufacturing and construction sectors, possibly reaching around 15-20 percent in the short-term 4. By tightening the budget constraint on enterprises, most enterprises would be forced to close or restructure. Over the medium and long term, the restructuring process and the reduction and eventual elimination of the extensive subsidy system would be expected to result in a better institutional and incentive structure, leading to a resumption of growth in the 1997/98 period (see Table 1, High Case). 16. Under such a scenario, the impact of the decline in the industrial sector is likely to be cushioned by increased agricultural production resulting from improvements in the incentive structure, and to a limited extent, by increases in energy production, mining and service sector activities. Cotton production could increase by up to 5 percent a year by 1996/97. Given the high share of cotton in exports, this could be expected to have a positive impact on the external accounts. As production from several large oil and gas projects comes on line, there will be increased output in those sectors. The mining sector also has strong potential and might provide a small stimulus for growth. However, unlike agriculture, both energy and mining comprise only a small share of GDP and therefore the potential spillover into the rest of the economy would only be limited in the short-term. Other sources of growth are likely to come from the service sector, which remains underdeveloped. With the removal of entry barriers and promotion of private sector activity, the service and trade sectors offer significant potential for further expansion. 17. If the Government takes a more gradual or piecemeal approach or if implementation proceeds at a slower pace, this would have an adverse impact on macroeconomic stabilization and the pace of recovery. Economic stagnation would be prolonged and the total cost to the economy -- measured in terms of lost output growth over a number of years - would be greater (see Table 1, Intermediate Case). Slower policy implementation would amplify uncertainty in the economy and impede private sector development. If the Government delays farm restructuring and reform of the incentive structure -- particularly the state order system -- the expected increase in agricultural production would not materialize. 'I/ Tn projected numbers should be viewed as simulations dependent upon assumptions conceming policies that may be implemented.  -6- Balance of Payments Prospects 18. Under the high case policy reform scenario, Uzbekistan's exports are expected to grow faster than import volumes owing to: (i) increases in production, particularly cotton and gold; (ii) slow but steady improvement in the FSU trade and payments system; (iii) diversification from the FSU market to the hard-currency market especially for cotton export; and (iv) improvements in the incentive structure of the trade system. The non-interest current account deficit could reach about US$200 million by 1998. Exports of manufactured goods would also grow from a low base in the medium- and long-term. Real export growth may average about 4 percent a year. Cotton exports are expected to respond to increases in production due to an improved incentive structure. Cotton exports to hard currency countries would increase by about 8 percent a year while exports to FSU countries would decline. Import growth would be relatively high in the initial years due to an increase in imports of capital goods and intermediate goods but would come down to about 2 percent on average per year since energy imports are expected to decline substantially. Table 1. UZBEKISTAN - Key Indicators High and Intermediate Case Scenario Projections High Case 1994 1995 1996 1997 1998 (prelimnmary) GDP Growth Rate (percent) -4.5 -6.2 -1.7 2.4 4.4 Consumption/Capita Growth Rate 2.2 -5.0 -0.7 2.7 3.2 Export Growth Rate (percent) 2.6 0.8 2.5 4.2 4.3 Import Growth Rate (percent) 7.4 5.4 2.0 1.6 1.4 Total DOD (Mil. USS) !' 1758 2279 2681 2966 3060 DOD/GDP 14.2 19.7 23.6 25.5 25.2 Debt Service (Mil. USS) 651 446 596 515 571 Debt Service/Exports Y 19.6 12.9 16.2 12.9 13.2 Interest/Exports ' 2.3 2.6 3.1 3.7 4.1 InterestlGDP 0.6 0.8 1.0 1.3 1.4 Internediate Case GDP Growth Rate (percent) -4.5 -6.0 -4.5 -2.5 -0.9 Consumption/Capita Growth Rate 2.2 -4.5 -3.8 -2.1 -1.6 Export Growth Rate (percent) 2.6 -0.1 -0.1 1.0 2.1 iponrt Growth Rate (pement) 7.4 1.4 -1.8 -1.0 -0.6 Total DOD (Mil. US1)1' 1758 2174 2329 2436 2447 DOD/GDP 14.2 18.8 21.0 22.6 22.9 Debt Service (Mil. USS) 651 446 588 463 480 Debt Service/Exports' 19.6 13.0 16.6 12.4 12.2 Interest/Exports Y 2.3 2.6 3.1 3.4 3.6 Intemest/GDP 0.6 0.8 1.0 1.2 1.3 !DeA 0uamwko d Debtd D. Y Expo of Goad I Svies.  -7- 19. Uzbekistan's medium- and long-termn balance-of-payments prospects are subject to substantial uncertainties. The high-case scenario assumes that comprehensive reforms are implemented rapidly. Slow implementation of the reform program -- especially in energy and agriculture -- would lower exports. In the energy sector, slower movement to international prices might encourage higher domestic consumption, a lower exportable surplus and higher energy imports. The domestic price for natural gas, for instance, is currently only at a very small fraction (less than 5 percent) of the export price. Furthermore, if reforms are not implemented at the pace envisaged for the high case, production increases especially in agriculture, will likely be much lower and reduce the exportable surplus. Increases in cotton exports alone are expected to be US$450 million between 1994 and 1998 under the high case; shortfalls would affect the current account substantially. In the natural gas sector, possible delays in projects expanding future gas production could significantly limit the exportable surplus. 20. Uzbekistan is also vulnerable to changes in the terms of trade, particularly for cotton which dominates the country's export base. For example, a 10 percent decline in the world cotton price would lower exports by an estimated US$130 million. Similarly, a 10 percent decline in the world gold price would lower exports by an estimated US$60 million. Moreover, Uzbekistan is a net oil importer and is exposed to changes in world oil prices. 21. External Financing. Over the medium-term, Uzbekistan will have significant external financing requirements. Total external financing requirements should decline from around US$1 billion for 1995 to about US$700 million by 1998 if the reform program is fully implemented (see Table 2, High Case). External financing will be required to cover the current account deficit, meet debt service obligations and to a lesser extent, build foreign reserves. Uzbekistan's reserve position covers currently over 4 months of imports and is expected to stay at about 4 months of import requirements during the forecast period. 22. Along with multilateral credits, official bilateral credits will be an important source for financing. In 1993, Uzbekistan received Russian state credits, which is used for CBU credit and to refinance Uzbekistan's debtor position in the FSU correspondent account system. Turkey has extended a long-term intergovernmental loan that is disbursing about US$130 million over 1994-95, and the Turkish Ex-Im Bank has established a revolving credit line of approximately US$40 million. In addition, official trade financing facilities have been established by agencies in the US, Canada, India, Indonesia, Japan and Malaysia. In 1993-94, Uzbekistan successfully attracted some US$370 million in commodity backed loans from Swiss and German commercial banks. Loans of this type may continue to be a source of short-term financing in 1995, however, the Government will have to avoid relying excessively on financing sources which are very short term and unattractive, as it did in 1993 and 1994. Some private sector trade financing, mainly from European commercial banks and corporations also has been contracted. Assuming that reforms proceed, foreign direct investment flows are envisaged to grow up to US$250 million per annum. Initial joint venture commitments have been concluded in the mining, textile and tobacco sectors, and there is some potential to attract investment in oil and gas. 23. If the reforrn program proceeds at a slower pace not only would the incentive for restructuring be lowered; the availability of external financing would be reduced, constraining the recovery of imports. Foreign direct investment, multilateral financing and export credits would also be smaller (see Table 2, Intermediate Case). Reduced capital imports would lower investment and future export prospects, and the longer term outlook for the external balance would be worse.  Creditworthiness 24. After independence Uzbekistan accepted the "zero debt option" and signed an agreement with Russia whereby it relinquished claims on USSR assets in return for Russia accepting responsibility for Uzbekistan's share of the USSR's external debt. Therefore, Uzbekistan started out with no external debt and this has had a positive impact on its creditworthiness. Assuming that the full reform program continues to be carried out, total external debt is expected to grow from about 14 percent of GDP in 1994 to around 25 percent of GDP by 1998. The debt service burden may rise modestly over the medium-term. Debt service payments are expected to reach 16 percent of total exports in 1996, declining thereafter to 13 percent by 1998. Debt service in 1994 is particularly high because of the short-term nature of Uzbekistan's initial borrowings. With the current account deficit slowly improving, debt service would account for an increasing share of total external financing needs. Loan amortization would grow in response to the build-up of medium- and long-term debt. Debt service payments to the Bank would increase to about 6 percent of total debt service payments and 0.7 percent of total exports by 1998. All exposure indicators are within Bank guidelines. In the longer termn, however, debt indicators might worsen since debt is building up from the very low level after independence. This refers to all debt, not only IBRD exposure. The share of IBRD debt to total debt will increase to about 19 percent by 1998 which highlights the major role the Bank is projected to play. 25. By the below indicators, Uzbekistan appears to be only moderately indebted. However, Uzbekistan's medium- and long-term creditworthiness will depend largely on its ability to: (i) deepen macroeconomic stabilization to reduce inflation and external imbalances; (ii) imnplement a comprehensive reform program; and (iii) mobilize sufficient external financing. Although external factors, such as changes in terms of trade, play a role, improvement in the current account is dependent primarily on implementation of a comprehensive reform program supporting export- oriented growth, particularly for cotton. A substantially higher deficit in the current account than projected for the high case, and a subsequent rise in external financing requirements, would increase total external debt and debt service payments and might impair long-term creditworthiness. If cotton F export performance is weaker than anticipated (1-2 percent growth) or if there are lower declines in energy imports, resulting from delayed program imnplementation, total financing requirements could be $200-400 million larger than projected under the high case. 26. To cover its external financing requiremnents in the medium-term, Uzbekistan will have to mobilize substantial flows of direct foreign investment, export credits and bilateral credits. The availability of these financial resources depends largely on the Government's ability to create a stable environment thereby reducing the perceived risks in investrnent. In the event that the reforms are reversed or stalled, the willingness of the financial community to lend would diminish, and access to required external financing would become more difficult. Furthermore, if direct foreign investment is slow to materialize, thus creating difficulties in the realization of export potential, creditworthiness could be jeopardized. Excessive dependence on, for instance, trade credits with short maturities, and the use of external financing for activities that are not econornically or financial viable could further impair creditworthiness.  9- Table 2. UZBEKISTAN - External Financng Requirements and Sources (1994-1998) and Bank Exposure Indicators High Case 1994 1995 1996 1997 1998 Total incng Needs (-) (Mil. USS) -1,022 -1,037 -1,082 -892 -743 Current Account Balance -411 -629 -611 -500 -335 Non-Interest Current Account -336 -544 -512 -372 -182 Interest -75 -84 - 99 -128 -153 Changes in Reserves -36 -50 11 -48 -59 Amortization -574 -358 -482 -345 -349 Total Fbnann Sources 1,022 1,037 1,082 892 743 Foreign Direct Investment 120 198 218 240 254 Multilateral Financing 53 374 263 224 164 of which: - World Bank 4 122 158 159 129 -EBRD + IMF 49 252 105 65 35 Bilateral Financing 582 389 272 97 67 Other 'I 267 76 330 332 259 Bak Expomue Ratio (percent) IBRD Debt Service/Exports 0.0 0.0 0.2 0.5 0.7 IBRD Debt Service/Public DS 0.0 0.0 1.6 4.1 6.2 Preferred Creditor DS/Public DS 2.0 3.7 5.0 9.4 11.7 IBRD Debt/Total Debt 0.2 5.5 10.6 14.9 18.7 Memo Items Reserve Stock (Mil. USS) 1,336 1;387 1,376 1,400 1,412 Reserves/Imports (months) 4.4 4.2 4.0 3.9 3.8 Intermediate Case Total Finacing Needs (-)(Mil. USS) -1022 -855 -764 -586 -505 Current Account Balance -411 -506 -428 -330 -177 Non-Interest Current Account -336 -422 -331 -220 -56 Interest -75 -84 -97 -110 -121 Changes in Reserves -36 9 144 71 -12 Amortization -574 -358 -480 -327 -316 TotalF xdng Sources 1022 855 764 586 505 Foreign Direct Investment 120 121 128 141 155 Multilateral Financing 53 219 164 116 124 of which: - World Bank 4 122 74 51 89 - EBRD + IMF 49 97 90 65 35 Bilateral Financing 532 369 152 77 47 Other 1' 267 76 320 252 179 Ban Expoue RatUs (percent) IBRD Debt Service/Exports 0.0 0.0 0.3 0.4 0.5 IBRD Debt Service/Public DS 0.0 0.0 1.6 3.2 4.1 Preferred Creditor DS/Public DS 2.0 3.7 4.9 8.4 10.0 IBRD Debt/Total Debt 0.2 5.8 8.6 10.3 13.9 memo item Reserve Stock (Mil. USS) 1336 1327 1177 1127 1107 Reserves/lmports (months) 4.4 4.2 3.7 3.5 3.4 Y 9.,Iim tmi, F ec Hus PltMey Gme4uot Ne tSb-Tenn Cim.  - 10 - D. COUNTRY DEVELOPMIENT OBJECTIVrES AND POLICIES 27. During the last few months, the Government has begun to translate its broad reform and stabilization objectives into a more comprehensive set of consistent economic policy initiatives. Key stabilization objectives and policies for 1995 have been specified and details of priority structural reforms measures have been or are being worked out in the context of a medium-term program. The main objectives of the Government's reform program are to: (i) stabilize the macroeconomic situation; (ii) reverse output decline, improve productivity and attain sustainable development over the medium-term; and (iii) protect vulnerable groups. Implementing the broad range policy agenda will require considerable effort by the Government and financial and technical assistance from the international community. Macroeconomic Stabilization 28. The Government's immediate task is to maintain momentum in lowering inflation and to avoid large macroeconomic imbalances in the budget and the balance of payments. The Government's stabilization program seeks to reduce the monthly inflation rate. An increasing share of Central Bank credit to the commercial banks will be auctioned, reaching 50 percent by the end of June 1995. Domestic bank financing of the budget is expected to be limited to 2 percent of GDP during 1995, and the consolidated budget deficit is to be limited to 3.5 percent of GDP. All subsidies and support to SOEs during the transition will be made explicit and channeled through the budget. Budgetary support to these enterprises will be on a very limited scale and will eventually be phased out. 29. In 1994 the Government has made progress in controlling the budget deficit, but reforms in expenditure management and tax policy are still required to reach the budgetary targets under the STF program. Furthermore, the structural reform process could temporarily decrease tax revenues by contracting the revenue base, since it takes time to tax an emerging private sector and it is expected that at least temporary economic activities will decline. Additional expenditure pressures will arise for the social safety net and for temporary transfers to support the passive restructuring of the largest loss-making enterprises which remain in the public sector. The Government realizes that meeting critical expenditure needs will require controlling wages, salaries and social expenditure. It plans to limit the wage bill of budgetary-financed organizations to 15 percent of GDP in 1994. Consumer subsidies will not exceed 2 percent of GDP. Recourse to extra-budgetary onlending has been eliminated, and the interest rate on overdue loans will be at the CBU's refinance rate. The revenue base will be broadened by eliminating tax deductions and exemptions and extending the value added tax (VAT) and excise taxes. Personal income tax, land tax and property tax rates will be increased. 30. Enterprise restructuring will make it necessary for the Government to assume some of the social expenditure formerly undertaken by SOEs. Assets not directly related to production will have to be divested, although some social assets could be privatized, many will be transferred to sub-national govermnents, since such outlays generally fall under local spending responsibility. The key challenges for the Government will be to: (i) determine which services can be provided by the private sector and which should be provided by the oblasts; (ii) estimate the costs of these outlays; and (iii) design and adopt a system of revenue assignments and intergovernmental transfers that provides sub-national governments with sufficient revenues to meet these and other assigned expenditures.  - 11 - 31. The Government recognizes the importance of a well-functioning foreign exchange market and intends to expand substantially the availability of foreign exchange through the inter-bank foreign exchange market and to ensure current account convertability. The auction-determined exchange rate is now used for all foreign exchange transactions by individuals, enterprises, banks and the Government. It is the policy of the Government and the CBU to limit intervention in the foreign exchange market to smoothing sharp fluctuations in the exchange rate, with no attempt to set a particular exchange rate. As foreign exchange availability improves, the Government intends to reduce and later abolish the current (temporary) 30 percent surrender requirement. Structural Refonrs 32. The success of the stabilization and reform program will depend largely on transforming state enterprises and farms into economic entities that respond to market signals. The Government intends to support this process by: (i) changing the incentive structure; (ii) fostering private sector development by privatizing state enterprises and establishing a more effective corporate governance structure; (iii) reforming the banking sector; and (iv) developing an effective social safety net. 33. Improving the Incentive Structure. In 1994, the Government realized that the existing subsidy system caused large fiscal problems and began to substantially reduce direct budgetary consumer, producer and credit subsidies and liberalized prices. In spite of these efforts, Uzbekistan's incentive system continues to be partially distorted by a variety of indirect subsidies, reliance on state orders, quantitative trade restrictions and anti-monopoly price controls. 34. The Government is currently developing a program to reduce the implicit subsidies. Gradual price liberalization of utilities, communication services and energy products and the implementation of user charges for water are planned by end 1995. The major remaining price distortions in Uzbekistan involve state orders on cotton and grain and household energy prices. For the 1995 crop, the Government has announced the reduction of the state order for cotton to 60 percent and to 50 percent for grain. The procurement price for cotton under state order has been be increased to 50 percent of the international price and for grain to 50 percent. State orders on grain would be phased out by 1997 and on cotton by 1998. Furthermore, the Government has recognized the need to revise the trade regime's incentive structure and to dismantle the centralized trade system. Auctions or other market mechanisms will be introduced to allocate licenses and quotas for exports of goods that remain subject to export licenses. 35. To improve the incentive structure, the Government will also abolish the indirect price controls imposed through the anti-monopoly commission. A sound anti-monopoly policy should prevent abusive monopolistic prices, not imposition of ex-ante price increases. The Government intends to place its anti-monopoly efforts in a general Competition Agency that will not be empowered to control prices. In certain sectors of the economy (energy, telecommunications, water) problems of natural monopoly will remain and some form of price regulation will be inevitable. To deal with these areas, the Government will establish an Office of Public Utility Regulation. 36. Foreign trade in Uzbekistan has been carried out with strict state control on exports of key commodities through export registration and licensing requirements and state monopolies on trading rights for certain product lines. In recent months, the Government has recognized that it needs to revise Uzbekistan's trade regime and unified tax treatment of FSU and non-FSU trade. Import tariffs have been temporarily removed until July 1, 1995, and the number of goods subject to export licenses has been reduced from 74 to 11 as of December 1994.  - 12 - 37. Privatization/Enterprise Restructuring. The Government believes that structural transformation of Uzbekistan's economy requires changing the ownership and organization of its productive sectors, which are dominated by state-owned enterprises (SOEs). Privatization and enterprise restructuring to achieve growth and efficiency has become a Government priority. To address this issue, the Government has designed and initiated a program to: (i) reduce financial transfers and subsidies to the SOEs; (ii) restructure SOEs; and (iii) improve corporate governance of SOEs which remain in the public sector. A set of principles for implementing financial discipline in the SOE sector, including the criteria for selecting non-viable enterprises to be isolated from the banking system and for identifying and selecting those that need to be restructured prior to privatization has been articulated under this isolation exercise, enterprises that remain under state control will be subject to strict budget constraints, with financial support being fully and transparently reflected in the 1995 budget for a limited number of essential, but loss-making, enterprises. The Government is reviewing the legal and regulatory framework for private sector development and operations, including laws governing market entry and exit, licenses and other regulations, access to inputs and credit, restrictions on employment levels, property rights, contracting and operations. 38. The Government is continuing rapid execution of Stage II of its privatization program and plans to convert most large (over 2000 employees) and medium (150-2000 employees) enterprises to open stock companies. While the Stage II program represented a significant advance in the general orn-ntation of the program, as described in para. 10, considerable problems concerning the quality, scope, timing, approach and institutional arrangements remain. To redress the deficiencies related to the partial privatization effected in Stages I and II, the Government recently issued a resolution permitting State divestiture of its own holdings. This will allow the Government to reduce the combined shares of the collectives and the Government to below 50 percent. In all remaining enterprises awaiting privatization, the combined share of the state and collective will be lower than 50 percent. Furthermore, in November 1994 the Govermnent removed profile restrictions on privatized entities; reduced ownership to minority equity positions in the stock exchange, National Investment Fund and the National Depository; and confirmed equal access by brokers to shares offered on the exchange. To effect a more comprehensive solution, the Government prepared and finalized an Action Plan for Privatization, which sharpens the scope of the program, and improves the pace of implementation through clarification of procedures and foster expanded public participation. The Action Plan includes: (i) dates and targets for enterprises to be corporatized and offered for sale; (ii) r,ules to govern the initial offering of shares that will limit control of both the Government and insiders over privatized medium and large enterprises; (iii) promotion of an expanded role for investment funds; (iv) guidelines for transparent and competitive tendering; and (iv) an agreement on information that needs to be widely circulated to the general public before selling SOE shares. The privatization scheme is expected to be adopted by May 31, 1995. 39. Financial Sector. Uzbekistan's banks have served as the mnain conduits for transferring subsidies to SOEs and the agriculture sector via unrealistically low interest rates, and without concern for the recipients' creditworthiness. To effect reforms, the Government will: (i) reduce significantly the volume of directed credit to the enterprise sector by implementing the isolation exercise; (ii) increase the proportion of credit to be auctioned among banks; and (iii) increase nominal deposit and lending rates in order to achieve positive real interest rates.  - 13 - 40. The Government's reform strategy in the financial sector currently encompasses four elements: (i) strengthening financial infrastructure; (ii) improving the functions and clarifying the responsibilities of the Central Bank; (iii) restructuring and privatizing the banks; (iv) developing contractual savings and securities markets and developing an adequate payment mechanism. As a first step, the Government is engaged in developing an appropriate legal framework covering: (a) basic financial sector laws and related legislation --secure lending, collateral, bankruptcy, commercial codes, securities, insurance; (b) accounting and auditing standards and practice and appropriate disclosure policies; and (c) a strengthened supervision and regulatory framework. Financial sector reform will also require a well functioning, transparent judicial system. Uzbekistan's policymakers will need to modernize and strengthen the judiciary to respond to emerging needs and further bolster investor confidence. 41. Substantial technical assistance has been made available to the Central Bank to strengthen supervision and enforcement functions of the two-tier banking system. The Government is in the process of reviewing the legal structure of the CBU and has drafted and submitted to Parliament, a law which would establish a high degree of independence for the CBU. Recently, new rules were adopted for regulating commercial banks. Among the next items on the agenda are restructuring the specialized banks (Savings Bank, Agro-Industrial and Industrial-Building Banks, and National Bank for Foreign Economic Affairs); designing an appropriate framnework for the 22 new entrant banks; developing contractual savings institutions and stock markets; and strengthening grassroots organizations such as credit cooperatives and credit unions. Sectoral Reforms 42. Agriculture. Increased agricultural production will be a key element in Uzbekistan's medium-term economic recovery and long-term growth. The Government's sectoral reform program envisages: (i) strengthening agricultural incentives by bringing producer prices for grain and cotton closer to international prices to generate a quick supply response; (ii) removing subsidies for agricultural inputs, withdrawing the state from the direct distribution of agricultural inputs and liberalizing distribution and trade; (iii) expanding the land reform and distribution programn; and (iv) promoting the effective use of irrigation water and cost recovery. The Government has initiated concerted actions in all of these areas. Reform of the incentive structure has been among its top priorities and a timne-bound action plan been developed (para. 35). The Government has also begun to develop a program to improve prospects for cotton, its key export. Progress in land reform and water policy, although underway, is not as advanced. Although about 25 percent (1 million ha) of total cultivated land is now under private control, much remains to be done to broaden the existing program of land reform, through transfer of control over land to a larger number of individual or corporate operators and transfer of assets to private ownership and use. In the cotton sub-sector the Government has also agreed to tradeable and transferrable 99 year leases. The Government announced plans to lease 25 percent of all irrigated land to private farmers and families by June 30, 1995, and an additional 15 percent by December 31, 1995. Independent owners are to be given full control over land leases and ownership of other productive assets to maximize their incentives for economic success. 43. The Goverrnent strategy focusses on revising the current system of allocating land and water resources which encourages farmers to neglect the impact of farming practices on soil fertility and land quality and to waste irrigation water and other productive inputs. Key actions will include: (i) promoting more efficient use of existing irrigated lands rather than expanding irrigation coverage; (ii)  - 14 - introducing marginal cost pricing; and (iii) developing a system of tradeable water allotments that over the longer term, may be converted to specific water rights. In the context of the Aral Sea initiative, the Government has also begun to develop a complementary strategy for addressing environmental concerns, particularly with respect to water rights, use and management (para. 49). 44. Energy. The Government's policy in the sector focuses on improving sectoral efficiency through accelerated development of the country's petroleum resources and gas-based petrochemicals for which import costs can be exceptionally high due to the cost of transportation from foreign supply sources. Such development would also substantially improve the country's balance of payments position. Development of the two largest oil fields, Kokdumlak and Mingbulak has thus been a priority. In parallel with this, the Government aims to rationalize and expand Uzbekistan's oil refining capacity so as to optimize future crude oil and product transportation. For gas, a key policy priority is to improve processing so as to extract additional gas liquids, which are at present in deficit. However while most of these planned investments in oil and gas supply and processing are expected to be economic, a major increase in both domestic and external financing is required in the near-term. Towards this end, the Government has been active in mobilizing external financing for oil and gas investments, including bi-lateral and multi-lateral credits, as well as commercial financing. Attracting foreign private investment in petroleum is proving difficult since Uzbekistan's' geographic situation leaves it extremely isolated from international energy markets, and hence from export outlets for oil and gas. 45. The Government has also recognized that energy prices need to be increased to economic levels so as to improve the efficiency of energy usage, and to raise internal financing for petroleum investment. The ex-refinery prices of gasoline, and diesel have already been raised to or close to international levels. However, the wholesale price of fuel oil is still at about 55 percent of the international price. The Government intends to raise all domestic petroleum prices and prices of petroleum products to international market levels by October 1995. The producer price for oil will be raised to at least 75 percent of the world price by March 1, 1995, and to 100 percent of the world price by October 1, 1995. At the same time, a suitable scheme will be put in place to capture the additional profits that will accrue to oil producers from the price rises. Increases in the import costs of petroleum products and coal will continue to be entirely passed through to domestic customers. The rates charged for some energy-related public utility services, such as central heating, hot and tap water service, and public transportation do not cover the cost of providing the services. To close this gap, retail prices have already been raised and will be increased further in 1995. The Government also intends to reduce substantially the cross subsidy between industrial and residential gas and electricity prices. At the institutional level, energy enterprises remain concentrated in large state-held holding companies, which are closely tied to the Government administrative structure. In the medium-term, emphasis needs to be placed on the commercialization of energy enterprises within a transparent legal framework. Efforts to attract foreign private investment in petroleum exploration and production are being reinforced through the development of a suitable legal, fiscal and institutional framework. 46. Mining. The medium-term outlook for the mining sector, particularly gold and copper industries, appears promising. Full commercial exploitation of Uzbekistan's substantial mineral resources will to a large extent depend on the Government's ability to quickly remove price distortions and revarnp the outmoded legal framework and centralized institutional structure. These actions would facilitate participation by private mining interests with the technological expertise to conduct exploration activities. Access to international markets has been limited because of state  - 15 - monopolization, however, recently the Government has begun to take steps to facilitate foreign investment, and the sector has attracted some investment from the European Bank for Reconstruction and Development (EBRD), the International Finance Corporation (IFC) and various private sector interests. In light of the potential attractiveness of the sector to foreign investors, the Bank's role would focus primarily on advice in the context of the overall policy framework rather than investment financing. 47. Infrastructure. Although Uzbekistan's transport infrastructure is relatively well developed and adapted to the country's geographic characteristics, a large part of its infrastructure must be modernized. The Goverrnment's main objective is to provide a new set of incentives to transform the sector by (i) designing new pricing and cost-recovery mechanisms; (ii) encouraging competition in areas such as road and air transport; (iii) developing support services such as gas stations, repair shops and spare parts supply for the private sector; and (iv) drafting new legislation to stimulate, support and regulate the private sector's participation in developing the country's infrastructure. For these reforms to be successful, the Government intends to revise the current institutional structure in these areas: first, clearly defining roles and responsibilities; second, assessing the effectiveness of current institutions with respect to new needs in the sector; and third, improving the management of human and financial resources. 48. Environment and Water Management. The Government's approach to environmental reform focusses on the Aral Sea Basin crisis, since the Sea's degradation has a tremendous adverse impact on the ground water and on the health of the population living adjacent to the Sea. Establishing a baseline for environmental health policy is thus one of Uzbekistan's most urgent needs. Drinking water quality is poor, does not meet Government standards in most regions of the country and is associated with many of the region's health problems. The Government recognizes the need to utilize water resources that historically have been wasted and mismanaged, in a more economical manner. To this end, in the agricultural sector, the Government is committed to rationalizing the use of pesticides and fertilizer and to implementing a new water management scheme. Sectoral goals include: (i) the reduction of water consumption through reconstruction of irrigations systems and other measures; (ii) the elimination water discharge to surface and underground sources; (iii) the reduction water losses stemming from transportation of water over long distances through more efficient demand planning; (iv) the establishment of higher standards for discharge water quality for all water users; (v) the promotion of better agricultural technology, (vi) the improvement of sewerage systems; and (vii) the construction of collectors for salted and drainage waters. The establishment of fines for indiscriminate dumping and price reforms for water and other inputs should provide incentives to save water resources. The environmental implications resulting from the degradation of the Aral Sea are but one facet of the country's complex ecological concerns. To deal with broader environmental issues, the Government plans to undertake a National Environmental Action Plan. 49. Health. The inherited health care system is characterized by an over-emphasis on input quantity rather than results and cost efficiency, as well as over-centralized management. To address these shortcomings, the Government's vision for the sector highlights: (i) redefining the role of Government in health care provision; (ii) rationalizing facilities; (iii) improving the quality of services, strengthening management; and (iv) exploring options for reforming health care financing. In anticipation of an overall institutional reform of the sector, the Government has begun to initiate some changes that should make the system more efficient (such as reducing the number of hospital beds) and focussing on such priorities such as family planning and maternal and child health.  - 16 - Poverty Alleviation 50. Poverty presents a significant problem for the Government. Official data prior to independence reflect a high incidence of income poverty among rural households, although their above average calorie intake suggests the importance of private plot consumption. Other dimensions of poverty show significant regional variations. Access to piped water, for example, averages only about 52 percent in rural areas (falling to below 10 percent in the autonomous republic Karalpakistan), compared to over 85 percent for urban residents. Rural access to safe sanitation averages less than 5 percent. More recent data suggest that 80-90 percent of the poor in Uzbekistan are families with children. During the transition, the large numbers of youth who will be entering the labor market for the first time may be especially adversely affected by tighter labor markets. 51. As has occurred in some other countries of the Former Soviet, inaction on structural reforms in Uzbekistan would only lead to economic decline and inevitably result in a greater proportion of the population sliding into poverty. Structural reform will be essential to sustained economic growth, and, hence, the start of this reform process sets the stage for reducing future poverty. A degree of hardship is inevitable during the transition associated with labor market adjustments and severe fiscal constraints which will hinder the social protection system and delivery of basic social services. The reform program is being designed with consideration to the need to protect vulnerable groups during this transition. The Govermnent has so far responded to the situation by adjusting its system of social protection to direct support to the most affected (paras. 52-55). The Government is beginning to identify the required reallocation of resources needed to strengthen delivery of basic social services including health and rural water and sanitation. However, the Govermnent does need to improve monitoring of the poverty impact of structural measures to ascertain whether further assistance is necessary. The Social Safety Net 52. Given its fiscal constraints, the Government faces significant challenges in transforming the social protection system inherited from the Soviet Union. Falling real wages throughout most sectors of the economy have lowered living standards. In addition, the present low levels of open unemployment are expected to rise quickly as enterprise restructuring gets underway. Furthermore, as enterprises and collective farms shed the burden of financing and providing social services, these responsibilities will increasingly fall on local authorities that may lack the necessary financial and administrative capacity. 53. The Government has recognized that support to families is a major element for protection of the most vulnerable during the transition. Family allowances were the best targeted instrument of social protection inherited at independence, yet, between 1991 and 1993 they were allowed to erode dramatically through non-indexation. In 1994, the Government simplified the system of allowances and increased real levels of benefits. Family and child allowances accounted for 1.8 percent of GDP in 1994. In August 1994 the Government introduced a new program of targeted assistance for low income families. This transfer to low income families accounted for 0.8 percent of GDP in 1994. Within three months of its inception, over 200,000 families were beneficiaries of the scheme. This program will require careful monitoring to ensure appropriate targeting and adequacy of budgetary allocations across localities.  - 17 - 54. The Government has developed a framework to deal with concerns about rising unemployment including the establishment of an employment service and the creation of an employment fund to finance benefits and training. The employment fund, an extrabudgetary mechanism funded by a 2 percent payroll tax, is expected to cover up to 1.5 percent of unemployment. If the unemployment rate exceeds 1.5 percent, the Government could use part of the savings derived from the changes in the indexation of pensions, reduce further consumer subsidies or increase the payroll tax. The Govemment is also beginning to simplify the structure of unemployment benefits and is reviewing options including the introduction of employee contributions and delinking benefits from the minimum wage. 55. Another major element of social protection is protecting the benefits of the most vulnerable pensioners while the system of pensions is being reformed. Uzbekistan's pension expenditures are too large relative to its demographic structure and GDP. Pension expenditure represented about 11 percent of GDP in 1994. The Government began to address this issue through enactment of a new Pension Law, approved in April 1994, which reduced the number of pensioner categories and modified the schedule to reduce the replacement ratio to about 40 percent. Now the Government is finalizing a system for adjusting pensions, whereby minimum pensions will be protected and overall pension structures will be reduced. The scheme is expected to be under implementation in the second half of 1995. Further measures to improve the effectiveness and fairness of the system are underway, including reducing benefits for working pensioners, reassessing the occupational categories entitled to early retirement, and expanding the payroll tax base to include enterprises outside the state sector. E. BANK GROUP'S COUNTRY ASSISTANCE STRATEGY Objectives 56. The Government's success in the transition from a command to a market economy over the next few years will depend on sustaining an appropriate macroeconomic stabilization program and implementing a comprehensive structural and sectoral reform program. The FY96-98 Bank country assistance strategy is designed to: (i) support macroeconomic stabilization and structural and sectoral reforms with focussed analytical inputs and lending; (ii) strengthen market incentives particularly in the two key productive sectors, agriculture and energy; and (iii) protect vulnerable groups through the establishment of an effective social safety net and more efficient, targeted service delivery. Bank support to structural and sectoral reform will be essential for sustained economic growth, thus preventing economic decline which inevitably would have a negative impact on the poor. In addition, the Bank would provide support to ensure or expand access to basic social services which are largely poverty focused. Bank support would also strengthen and reinforce the Government's institutional capacity and serve as a catalyst for aid mobilization and coordination. Past Bank Assistance 57. Although the Government is now fully engaged in implementation of a comprehensive reform program, program start-up was somewhat later than in other FSU countries. Bank assistance since Uzbekistan joined the Bank in September 1992 has focused on policy dialogue, lending to support the design of the reform program and institution building.  - 18 - 58. Analytical Work. The Bank's economic and sector work has provided the basis for advising the Government on policy design and implementation. The first Country Econonmc Memorandum, prepared in FY94, provided an assessment of the country's macroeconomic framework, structural and sectoral characteristics, prospects and constraints for medium-term growth and a reform agenda for the transition to a market economy. A second Economic Memorandum, focusing on the assessment of the explicit and implicit subsidy structure. was discussed with the Government in May 1994. A social sector report entitled "Adjusting Social Protection", which covered policy options and evolving needs in social protection, labor markets and health was discussed with the Government in July 1994. In line with the Bank's strategy of initial concentration on key productive sectors, an agriculture review is in progress and will be discussed with the Government. An energy sector review is scheduled for the second half of FY95. A Japanese Grant is financing the preparation of a strategy for reform of the gas sector, including recommendations for priority investments and policy and institutional reforms. These findings will be incorporated into the energy sector review. The energy and agriculture review findings are also expected to provide the basis for future Bank lending in the sectors. 59. Institution Building. The first phase of the Bank's assistance strategy concentrated on developing the Government's institutional and technical capabilities through dialogue and studies on the design and implementation of a broad-based reform effort. The primary instrument of this strategy was the Institutional Building Technical Assistance Loan, approved by the Bank in October 1993. The loan's main objectives are to: (a) provide support to the Government in formulating and implementing reforms in the short-term; and (b) support institution and capacity building needed to implement and sustain reforms over the medium-term. 60. FY95 Lending. In mid-1994, the Bank began preparation of a quick disbursing policy-based Rehabilitation Loan. The $160 million Loan, which is intended to provide urgently needed balance of payments support, is designed to help the Government prepare and implement the structural reform program, liberalize the existing foreign exchange market, and help stem economic disruption resulting from the breakdown of the payments system. As in the cases of similar loans to FSU countries, the program concentrates on key up-front actions: phasing out state orders; designing and implementing a privatization program for medium and large-scale enterprises; and initiating steps to isolate a selected group of distressed SOEs from the financial sector. It is expected that the Rehabilitation Loan will be the first in a series of policy-based operations in support of the Government's enterprise restructuring and financial sector reform programs. 61. In agriculture, the Bank agreed with the Government on a first operation in the cotton sub- sector which accounts for 45 percent of cultivated land and is the key foreign exchange earner. A Cotton Sub-Sector Improvement Project, planned for presentation to the Board later in fiscal year 1995, will support: (i) the development of a private cotton planting seed industry; (ii) introduction of more effective grading and marketing systems to sell cotton in external markets; and (ii) improved irrigation and pest management practices. Proposed FY96-98 Lending Program: A Graduated Response Strategy 62. The proposed Bank strategy is one of graduated response: the level and composition of Bank lending will be adjusted according to the pace at which the Government executes its economic reform program. Increases in Bank support will be provided as the Government fulfills specified triggers. If the Government's performance conforms to all of the triggers, the Bank's program could encompass a  - 19 - blend of policy-based lending, investment projects and technical assistance in priority sectors. Under an intermediate case scenario, there will be no policy-based lending and the size of the investment projects will be scaled down. Under a low case scenario, very limited project activity in extremely selected areas is anticipated. These scenarios and the associated triggers are described below and are outlined in detail in Table 3. 63. Under an intermediate case scenario, eight investment operations totaling a maximum of $550 million ($8 per capita/per annum) would be supported during the FY96-98 period. The sectoral investments would be highly selective, concentrating in key sectors (agriculture, energy, health and water) where need is greatest, impact is rapid, other donor involvement is limited and where there is a case for public investment. This intermediate case would be predicated on fulfillment of a number of policy triggers, among others: reduction of state orders, progress on the privatization program, particularly in small scale enterprises, initiation of an isolation exercise for non-viable enterprises and development of the legal framework for private sector activity. In addition, progress on sector specific reforms would also be required in each sector benefiting from Bank lending. These are described in para. 68 below. 64. If the Government makes strong progress on implementing the reform program, the Bank would move to a high case lending scenario. Such a move would be contingent on fulfillment of the intermediate case triggers plus: (i) implementation of a sustainable macroeconomic stabilization program supported under an IMF stand-by arrangement; (ii) fulfillment of an additional set of triggers indicating intensified progress in key areas; and (iii) the existence of satisfactory implementation capacity. The additional triggers for the high case are described in Table 3, but include, among others, complete elimination of state orders for cotton and grain as agreed with the Government under the Rehabilitation Loan; completion of the small-scale privatization program and progress on medium- and large-scale privatization consistent with a pace to complete the program by end-1996; good progress on the isolation exercise for the largest non-viable enterprises; elimination of directed credit programs, improvements in the social safety net and more efficient pricing for energy. 65. In this case, the Bank's lending program would be enlarged to include two structural adjustment loans and to increase the size of selected investment loans. The number of investment loans would remain the same as in the intermediate case (eight) and the increase in size would be consistent with the enhanced capacity of the Government to implement a larger program. Total lending under this scenario would range up to $850 million ($13 per capita/per annum) for the ten operations over the FY 96-98 period. 66. The two adjustment loans would support the Government's efforts in privatization, enterprise restructuring and financial sector reform. While privatization and foreign investment should facilitate restructuring and modernization of viable enterprises, technical and financial assistance will be needed for restructuring, downsizing and, in some cases, liquidation of large loss-making enterprises. Under the high case, the Bank would support progress in this area through an adjustment or hybrid operation, the Enterprise Restmcturing Operation in FY96. Loan design would benefit from the experiences of the Bank-supported Rehabilitation and Trust in Kazakhstan and the Restructuring Facility in the Kyrgyz Republic. The operation would also support critical financial sector reforms, given the close linkages between enterprise reform and financial sector reform. This operation would be followed by a Structural Adjustment/Financial Sector Loan in FY97.  - 20 - 67. If the reform program stalls, or proceeds at a very slow and/or uneven pace, the Bank would respond with a low case program of selected technical assistance to reinforce fragile capacity and, possibly, limited investments in basic service delivery or infrastructure. Total low case lending would accommodate no more than one operation per year, for a total of under $150 million over the three year period. In the event of prolonged macroeconomic instability country creditworthiness constraints would be reviewed. Sectoral Composition of the Investment Program 68. The sectoral composition of the investment program reflects the priority needs for public investment in the economy and is described in detail in the paragraphs below. Before the Bank undertakes projects in any of these sectors, however, progress in key areas critical to the success of investments in that sector would be required. In particular, for energy, substantial increases in the average level of domestic prices for liquified petroleum gas would be required before a project to enhance LPG production would be considered. Further energy sector investments would be linked to progress in addressing the issues of pricing for other energy sources, as well as taxation and the institutional framework. Because the proposed agricultural lending program comprises a large share of the overall program, reforms in this area are particularly important. Before any lending is undertaken in the agricultural sector, state orders must be phased out at a pace consistent with that agreed upon under the Rehabilitation Loan, input subsidies must be substantially reduced, progress must be made in shifting control over land to the private sector, and the program to privatize marketing institutions for inputs and output must be well advanced. For lending in the health sector, progress on health care financing is a prerequisite. Finally, improvements in cost recovery and water pricing are critical for investments in the area of water and drainage. 69. Agriculture. Given the agricultural sector's importance in the economy, the Bank has been closely involved with the Government in identifying an approach for fundamental structural change in agriculture. To allay concerns about possible adverse effects on employment and productive capacity during the transition, the Bank agreed with the Government on a phased program of sectoral interventions, beginning with the establishmnent of an appropriate incentive framework followed by investments geared to redress key sectoral constraints. The first two operations prepared under this strategy are the Rehabilitation Loan and the Cotton Sub-sector Improvement Project. Subsequently, shifting control of land resources and ownership of farm assets to private producers will be crucial to ensure efficient agricultural production in the medium-term. The proposed Agricultural Services and Farm Support Project, tentatively scheduled for FY97, will pilot appropriate institutional arrangements and intra-farm organizational arrangements to enhance productivity and sectoral efficiency. The loan would finance basic infrastructure and inputs, strengthen agricultural services and develop models for privatization and farm restructuring. The Bank is evaluating the Government's approach to line reform in the Agricultural Sector Review. This analysis will be deepened in the context of the Agricultural Services and Farm Support Projects. A number of options for subsequent sectoral investments will be considered in view of the findings of the Agriculture Sector Review, now under preparation. Possibilities include an Export Development Project for fruits and vegetables and sericulture. L  - 21 - Table 3: UZBElaSTAN: KEY SCENARIOS MACRO- PROPOSED BANK ECONOMIC STRUCTURAL AND SECTORAL REFORMS PROGRAM ENVIRONMENT HIGH CASE Macroeconomic Intermediate case triggers have to be fulfilled. Enterprise Restructuring stabilization Incentive Structure SAL/Financial Sector program supported - elimination of state orders and increase in procurement prices for cotton and Shurman LPG by agreement with grain as agreed with Government under the Rehabilitation Loan Water Supply the DIF on a - elimination of input subsidies nd reduction of goods subject to export licenses Agricultural Support & stand-by Privaizaution On-farm Dev. arrangement - completion of small scale enterprise privatizaton Health - continuation of medium- and large-scale enterprise privatization at pace Export Dev. agreed under the Rehibilitation Loan Drainage - combined state/coilective share of all enterprise stocks reduced to less than 50 Infrastructure percent Enterorise Reform up to US$850 m - identification and isolation of 30-50 enterprises with largest arrears - initiation of, and pmgress under, pilot restucturing pmgrm for enterprises - initiation of, ad contnuing pmgress under, the program for improvement in govemance for enterprises rermaning in the public sector Financial Sector - eltnination of directed credit programs-enachnent of the basic financial sector legal frmework (CBU LAw/Commercial Balking Law/Secured Lending, Collateral an Bankruptcy Law) - strengthening of CBU's regulatory and supervisory independence -Social Safetv Net - agreement on financia franework to support key soctIa safety net measures - miprovement of targeting and evauaton of progrms for social pmtection - reduction of pension expendiures to below the current 11% of GDP Enersy - all domestic petroleum and petmrleum product prices raised to international prices - reduction of cmss subsidy between industrial and residential gas and electicity prices INTERMEDIATE Some pmgress Incentive Structure No auick-didbursinm CASE toward monetary - reduction of sate orders as agreed with Government under the Reiabilituion onerations and budgetary Loan stability, economy - procurement prices on grain and cotton increased toward worid market prices is stabilized over Privatization investment lending - up longer period (3-4 - substntial completion of small-scale privatization and pmgress on privatization to 8 operations in years) targets for medium and lae scale enterprises priority sectors - - reduction of combined state/collective shares in the stock of enterprises already agriculture; energy; privadized to less than 50 percent water; health Enteurise Reform - development of die legal famework for private sector activities (including entry and exit law, licenses and pmperty rights) - development of criteria for selectng non-viable enterprises for isolation from the up to US$550 m banking system Financial Sector - progress in shifting financial support to entrerprises from directed credit to temporary, utsparent budgetary support - full ansparency in the budget of financial support to enterprises that rernin in the public sector and agricultura credit programs - prepartion of basic financial sector laws (including bankruptcy laws tnd contmercial code) Social Safety Net - initiation of process to utafer social assets to local governments - improved effectiveness of pension system (revision of system for indexing pensions; reduced pensions for working pensioners; expansion of the paymll tax outside the sate enterprises; reduced administrative costs) Enemyv - increase in die export price of natural gas - significant pass-through to domestic consumers of the increase in import costs of petroleum nd petroleum products - increased retail prices for energy-related public utlity services Land Reform - at least 40 percent of irrigated lnd available for leasing  - 22 - TABLE I (contd.) MACRO- PROPOSED BANK ECONOMIC STRUCTURAL AND SECTORAL REFORMS PROGRAM ENVIRONMENT LOW CASE Macroeconomic Incentive Structure Targeted lending only- instability - limited progress on removal of subsidies. state orders TA /basic services) of (hyperi2iflation. Entemmrise Reforrn up to one opeation a unsustainable - privanuzaon progress stalled year. totalling up to budget deficit) - constrints on private sector development USS150 million - limited enforcemenc of fiscal discipline on enterprise sector - restrints on competition in input and output disaibution Financial Sector - banking reform stalled Large directed credit programs intact Social Safety Net - lrge unargeted consumer subsidies - social assets remaLin responsibility of enterprises Other - price controls,large import subsidies and restaints on exports - restricons on foreign exchange - land distibunon programn saIls 70. Energy. The thrust of the Bank's assistance in the energy sector, particularly the oil and gas sub-sectors, is to support policy reforms and priority investments which are financially and environmentally sustainable. The Bank has collaborated with the Government in the development of a gas sector strategy, including prioritization of investments. Further sector work will address issues and options for reforms in the oil and gas sector. Targeted Bank financing will focus on the design and implementation of investments in the gas sub-sector which are less likely to attract private investments. The objectives of the proposed Shurtan Liquified Petroleum Gas (LPG) Project, programmed for FY96, are to: (i) enhance economic production of LPG from Shurtan gas (which accounts for some 40 percent of natural gas in the country) and enhanced use of LPG as a transport fuel; (ii) strengthen institutional capabilities to improve efficiency; and (iii) promote rationalization of LPG pricing. Separately, Bank participation in the oil sub-sector aims to facilitate mobilization of financing from the international community through technical assistance in petroleum legislation, acreage tendering and advisory services for oil projects under the ongoing Institution Building TA Loan. Further investments in the sector will be discussed in the context of the findings of the Energy Sector Review. 71. Social Sectors/Human Resource Development. Until the end of 1994, the Bank's strategy was to assist Uzbekistan in its social policy challenges prinarily through policy dialogue. The Institutional Building Loan, supports the Government in developing the employment service and in monitoring poverty monitoring capacity. In October 1993 a mission presented the options for World Bank financial assistance, ranging across the areas of health, social protection and training. Subsequent discussions centered on the Government's shift toward faster implementation of a r comprehensive reforn program and concerns about adequacy of the social safety net and service delivery. To this end, work has begun to prepare a FY97 loan to upgrade the health delivery system within a reformed policy environment to ensure the availability of a basic package of services. 72. A series of planned operational interventions planned will have a specific poverty focus, and are linked to structural reforms that would improve efficiency and equity. The proposed health delivery project is being focussed upon the needs of women and children, in particular, to improve women's reproductive health. The proposed water supply project (see para. 73) will significantly improve living conditions and the environmental health of at-risk rural residents. The Aral Sea program will benefit residents living in the poorest region of the country (see para. 74). The results of a Bank-sponsored household survey in mid-1995, as well as the longer-term results of poverty monitoring carried out under the IBTA-loan, will determine the design of ongoing and future lending operations.  - 23 - 73. Environment, Water and Sanitation. The indiscriminate use of water in agricultural activities along river basins and its collection and drainage into the rivers, has caused contaminated drinking water to be the single most crucial environmental problem in the country The Bank strategy will assist Uzbekistan Eo address these issues and related health concerns through policy advice and two complementary interventions, a rural water supply project and a drainage operation. An anticipated health sector operation would also have significant linkages. Although nearly 85 percent of the urban and 52 percent of the rural population have access to centralized water, its quality is variable and the rural population is particularly affected. Nearly one third of water delivered in the cities and over half delivered in the countryside do not meet Government standards. A Water Supply Project, slated for FY97, will support Phase II and III of the Govermnent's potable water strategy in the rural areas, sewage treatment systems and the development of an appropriate cost recovery and pricing mechanisms. 74. In line with the Government's emphasis on improving conditions in the Aral Sea and in view of the need for cooperation among the rural enterprises and entities, the Bank is actively promoting a regionally coordinated approach to addressing environmental problems by strengthening the Interstate Council for the Aral Sea and its Executive Committee, and by mobilizing grant resources for a program of regional studies. It will also assist in directly financing projects of national interest. Under this umbrella, work is underway to assess the viability of a drainage operation, the Right Bank Collector Project, which will respond to the Government's overall environmental strategy and concerns about rural poverty. This operation will develop basic infrastructure to correct problems related to water-logging, soil salinization, excessive irrigation water use and over- and inappropriate use of chemical fertilizers and pesticides. 75. Infrastructure. The Bank's focus would initially be on rural infrastructure (in particular water supply and sanitation, rural roads, and social facilities) because of the importance of the rural population (about 60 percent of the country's) and the urban bias of the past infrastructure development. The main policy areas to be addressed would be (i) cost recovery; (ii) development of local government capacity to plan and implement rural works; and (iii) promotion of small scale, employment-creating construction activities. The main objective would be to help the Government formulate a comprehensive approach towards rural infrastructure, which it considers a high priority for the short- to medium-terms. A first operation planned for FY98 would help introduce cost recovery as well as develop and test institutional arrangements and procedures for planning and implementing rural works through local contractors. The loan would finance the rehabilitation of existing water systems and rural roads, the completion of unfinished water supply systems, village health centers, and primary schools, and the development of local institutions. Economic and Sector Work (ESW) 76. The Bank will continue to prepare annual economic reports which will underpin our country dialogue. The reports will assist in monitoring program progress and strengthening policy advice. These reports will contain an assessment of the status of reforms and will focus on an important cross-sectoral issues, since more selective and in-depth work on policy matters is crucial to project development and policy dialogue. In the future, the Bank envisions emphasis on short policy notes that will provide a quick response to the Government. The FY96 report will focus on inter- governmental finances and divesture of social assets, which will integrate issues related to enterprise restructuring, stabilization and the social safety net. Other ESW activities and will have a direct impact on the lending program include an energy sector review, a poverty assessment, a national environmental action plan and an infrastructure review. U.  - 24 - Capacity Building 77. The ability of Uzbekistan's policymakers to implement their refomi program at an accelerated pace will be contingent to a significant degree upon institutional capacity. The effective utilization of the resources provided by the Bank and other donors will depend on strengthened implementation capacity and ownership of the program. 78. The Institutional Building Loan was designed to provide the Government with resources to organize and develop a solid base for the management of technical assistance and external assistance. The Loan finances consultant services, training and equipment for: privatization and enterprise reform; the payments system; external debt management; social protection; and sector studies. It is also instrumental in supporting the development of the necessary legal and regulatory framework for financial sector reform. Despite initial start-up problems, significant progress has been made. In particular, the Government has begun to improve coordination in intra-governmental decision-making. Besides providing training through the Economic Development Institute (EDI) on project evaluation, and familiarizing Government officials with Bank procurement and disbursement procedures, the Bank will continue to support management capacity building in individual projects. At the request of the Government, a Resident Mission was established in Uzbekistan in September 1992. The mission plays a key role in enhancing and deepening the policy dialogue, overseeing program ownership, as well as serving as a conduit for supporting technical assistance, program preparation and implementation, aid coordination and monitoring political and economic developments. Aid Coordination/Resource Mobilization 79. As the Government accelerates its reform program, it will increasingly need to deepen its links with international organizations. Uzbekistan joined the IFC and MIGA in 1993 and membership in the Asian Development Bank is pending. The EBRD and the European Union (EU) have begun to expand their country involvement. Bilateral donors have also shown increased interest in the Government's reform program. Prospects for expanded cooperation and sectoral sharing of labor and resources among donors are favorable but may require some time. To date, the Bank has played a catalytic role in assisting the Government in the design phase of its program and in securing its financing. In the next few years, we expect that the Bank will, together with the Government, continue to play a key role in donor outreach and coordination. The Consultative Group (CG) mechanism, therefore, remains an important instrument in the Bank's assistance strategy. Under the CG umbrella, a number of local meetings have been organized and a pre-CG meeting was convened in December 1993. A formal CG is scheduled for March 1995. 80. To respond to the Government's limited capacity to manage external aid, an IDF grant was approved to support the establishment of an external assistance management unit. The unit is responsible for ensuring effective management of financial and technical external resources and improving resource mobilization capacity. Unit staff will also coordinate official and humanitarian assistance to the country. L  - 25 - Role of IMF and Other Intermational Institutions 81. The IMF completed its first Article IV Consultation in 1993 and has provided technical assistance on monetary, fiscal and statistical issues since 1992. A macroeconomic stabilization program under an STF was approved in January 1995. The program consists of a first drawing under the STF facility in an amount of SDR 49.875 million, and a second drawing of the same amount based on understandings on a program supported by a stand-by arrangement or an understanding with the IMF on a comprehensive adjustment program. 82. IFC has assisted the Government in negotiating joint ventures for a gold mining project, hotels and is considering on a leasing company project. For the future, IFC intends to focus on foreign exchange earning sectors, natural resource development, hotels, cotton and silk processing, infrastructure projects, capital market operations and advisory services to foster privatization activities. MIGA received 6 preliminary applications for guarantees in the manufacturing, gold mining, oil, gas, and telecommunication sectors. MIGA has issued coverage for a gold ore processing project in Uzbekistan, with 4 European and American banks participating. 83. The EBRD has approved a credit line of US$60 million for the National Bank. EBRD is also investing US$55 million to develop a gold mine project and is assisting in developing the regional Bank training center and pursuing opportunities in the energy sector. It is also identifying opportunities to involve private firms in the agro-industrial sector, with a special interest in the rehabilitation of processing plants. The EBRD is also providing technical assistance for project formulation in the agro-industrial sector. Negative Pledge Waiver 84. In 1992 the Government requested a waiver of the negative pledge policy in order to facilitate foreign investment. Although no agreements have yet been concluded under this waiver, the Government has requested an extension. Uzbekistan has met established eligibility requirements and there appears to be an emerging demand for secured financing. A reconmmendation to extend the waiver for two years was approved by the Bank's Board in January 1995. Risks 85. The program faces substantial external and internal risks. In the short-term, the main internal risk is that policy efforts to stabilize the economy will be insufficient. While recent developments are encouraging, it is not yet clear how quickly the Government will move to implement the wide array of policy measures. Policy slippage on the stabilization and structural reform program may result from: (i) inadequate understanding of and conmmitrnent to fundamental elements and linkages of the reform program; (ii) weak institutional capacity; and (iii) popular discontent arising from declines in output and employment. In addition, Uzbekistan faces significant external risks, which include: (i) vulnerability to relative price shifts in the markets for its export cornmodities - cotton, energy and gold; (ii) supply bottlenecks in the FSU as some of the traditional import links are broken, especially in Russia; and (iii) lack of sufficient external financing.  - 26 - 86. The proposed Bank assistance strategy supports a well-phased program of adjustment and investment operations, bolstered by economic and sector analysis, continuous policy dialogue and technical assistance. As the Government introduces key reforms and gradually devolves functions to the incipient private sector, it will be able to expand its own capacity-building efforts and enhance its focus on priority functions. To mitigate the risks of potential social instability arising from declines in output and employment, the Bank has engaged in continued dialogue with the Government on the design and implementation of a social safety net to lessen the impact on vulnerable groups. To reduce external risks, the Bank has worked with the Government on two fronts: the design a program for improvement of the quality of cotton to reduce sensitivity to a downturn in the world market prices and policy measures and technical assistance to promote diversification of the export base. Finally, the proposed assistance program is self-adjusting. As the Government demonstrates its ability to implement and sustain a comprehensive reform program and deepens its stabilization efforts, Bank policy based lending will play a larger role. In the event of delays in the imnplementation of the reform program or should policy slippage or reversals occur, the lending program would be adjusted or reduced according to the Government's willingness and ability to implement specific operations. F. AGENDA FOR BOARD CONSIDERATION 87. 1 he Bank's assistance strategy for Uzbekistan focuses on supporting the country's transition to a market economy. The level and composition of the Bank's assistance will adjust in accordance with the country's policy and program performance. Since early 1994, there has been an acceleration in program implementation and progress in stabilization. Assuming that this orientation continues, we recommend that the proposed Bank lending program shift to a high case scenario, incorporating policy-based lendin2 for enterprise restructuring and financial sector reform. In this event, high case lending would support up to 10 operations in the range of US$850 million over the FY96-98 period. In this context, the Board may wish to address the following points in the course of discussion: * the proposed lending program including: policy content; focus, sequencing and proportion of quick-disbursing operations; composition of the sectoral investment program; and volume * the appropriateness of proposed triggers Lewis T. Preston President by Sven Sandstrom  - 27 - ANNEX 1 UZBEKISTAN: PROGRAM PRIORITIES AND GOALS SECTOR INVESTMENT PRIORIlIES POLICY GOALS PROPOSED PROJECTS I. AGRICULTURE Cotton Privauzation of seed production and seed Conon Project (FY 95) processing industry Liberalization of conton seed and coaon lint prices Removal of state order and export licenses Drainage Improvement of water quality and Right Bank Collector efficiency of water use Project (FY98) Alternatives for disposal of drainage water Institutional development Farm Restructuring and Privatization of agricultural production Agricultural Services and Production Optimization Development of a leasing option for land Farn Support (FY97) Elimination of input subsidies Pricing of water and land leases Export Crops Privatization of farms Agriculturm Export Market liberalization Development (FY98) I. ENERGY & INFRASTRUCTURE Potable Water Supply and Water safety Water Supply, Sanitation Rural Sanitation Sanitation and Health - rural areas- Sewerage Treatment Systems Water pricing (FY97) Gas Rationalization of LPG prices Shurtan LPG Project Institutional Reform (FY96) Mobilization and coordination of financing for major investments Gas (expected) Reform of energy institutions Energy (FY98) Fostering of an enabling environment for FDI Rural Infrstrcture Cost recovery. Development of local Infrastrucatrc (FY98) government capacity to plan and implement rural works. Promotion of small- scale construction activities. 1II. SOCIAL SAFETY NET a. Health Basic health care Improve efficiency of health care delivery Health Project (FY97) Focus on mnaternal & child and financing system health IV. QUICK-DISBURSING LENDING Fast disbursing assistance to Change incendve structure (state orders, Rehabilitation (FY95) support transitional program of subsidies, trde liberalization) sabilization and sttural Enterprise refominprivatzationr governance Enterprise Reform (FY96) reform (only in hIgh ca) Social safety net Enterprise reform/corporate govenknce/privaization SAL/Financial Sector Institutional development (FY97) Financial infructure (accounting, (only hI high cnc) audidng, legal framework, hunan resources development) _ntttion Duiding TA  - 28 - ANNEX 2 UZBEKISTAN: BANK GROUP FACT SHEET IBRD/IDA Lendina Proyram - Hi2h Case. FV94-98 Past Planned Category FY93/94 FY95 FY96 FY97 FY98 Commnitments (US$m) 21.0 230.0 210.0 300.0 340.0 Sector (%) Agriculture 33.0 25.0 26.0 Industry & Finance 57.0 33.0 Energy 43.0 24.0 Health 16.0 Environment & Water 25.0 29.0 Infrstctumre 20.0 Rehabilitation 67.0 Multisector/TA 100.0 TOTAL 100.0 100.0 100.0 100.0 100.0 Past Planned 93/94 95 96 97 98 Lending instrument (S) Quick-disbursing loans 0.0 67.0 57.0 33.0 0.0 Specific investment loans & others 100.0 33.0 43.0 67.0 100.0 TOTAL 100.0 100.0 100.0 100.0 100.0 Disbursements (USSm) 1.0 122.0 137.0 159.0 129.0 Repayments (USSm) 0.0 0.0 0.0 0.0 0.0 Interest (USSm) 0.0 0.0 9.0 20.0 31.0  - 29 - ANNEX 3 Statement of IFC Investments As of January 12, 1995 (US $ million) Type of Fiscal Year Obligator Business IFC Loan IFC Equity Participants c/ Total 1994 Amantaytau Gold Mining 0.0 1.0 4.0 5.0 Gold Fields Co. Total Gross 1.0 4.0 5.0 Commitment a/ Less Cancellations. Terminations, 1.0 4.0 3.0 Repayment and Sales Totl Conmmitment Now Held b/ 1.0 4.0 5.0 a/ Gross commitments consist of approved and signed projects. b/ Held commitments consist of disbursed and undisbursed investments. c/ TMe participants in the joint venture, which to date has undertaken a feasibility study of the gold mines are: Government of Uzbekistan, Lonhro Co. (UK), and the IFC.  - 30 - ANNEX 4 Technical Annex 1. The attached tables I to V present the high case scenario for Uzbekistan's medium-term prospects and financial requirements. The assumptions for the high case are presented in the section of the main report on Economic Prospects and External Environment. Assumptions about exogenous factors such as international inflation and trade commodity prices are those produced by the International Trade Division of the International Economics Department of the World Bank in November 1994. The model is a simple LOTUS-based RMSM. The model does not provide projections for the monetary sector. 2. The following abbreviations are used in the tables: GNFS Goods and Non-Factor Services NFS Non-Factor Services DRS Debt Reporting System LT Long-Term ST Short-Term N.E.I. Not Elsewhere Included DOD Debt Outstanding and Disbursed DS Debt Service 3. Table VI provides a comparison of the main indicators in the intermediate and high case. r  - 31 - UZBEKISTAN - NAT:ONAL ACCOUNTS TABLE I Prelim. Projections 1993 1994 1995 1996 1997 1998 A. National Accounts Indicators as Shares of GDP in Constant 1993 Prices (l) Gross Domestic Product m.p. 100.0 100.0 100.0 100.0 100.0 100.0 of which: Agriculture 23.0 24.6 26.8 28.1 28.3 28.0 Industry 36.0 35.7 32.8 30.6 29.0 28.6 (of which Manufacturing) 19.1 18.4 16.1 14.4 13.4 13.2 (of which Mining) 7.0 7.6 8.3 8.6 8.7 8.6 Services 31.0 31.5 32.9 34.3 34.9 35.1 Resource Balance -1.7 -2.5 -3.5 -3.6 -3.2 -2.6 Exports of GNFS 12.3 13.3 14.3 14.9 15.1 1S.1 Imports of GNFS 14.0 15.8 17.8 18.4 18.3 17.8 Total Expenditures 101.7 102.5 103.5 103.6 103.2 102.6 Total Consumption 72.3 78.1 79.7 81.1 82.0 81.7 Private Consumption 33.0 41.0 46.1 50.4 52.9 53.5 General Government 39.3 37.1 33.6 30.8 29.2 28.2 Gross Domestic Investment 29.4 24.5 23.8 22.4 21.2 20.9 Fixed Investment 25.6 19.6 20.1 19.8 19.3 19.4 Changes in Stocks 3.8 4.3 2.8 1.6 0.7 0.3 Terms of Trade Adjustment 0.0 0.9 0.9 1.2 1.S 1.9 B. National Accounts Growth Rates (%) at Constant Prices Gross Domestic Product m.p. -4.5 -6.2 -1.7 2.4 4.4 of which: Agriculture 2.0 2.5 3.0 3.0 3.5 Industry -5.4 -13.7 -8.5 -2.7 2.8 (of which Manufacturing) -8.0 -18.0 -12.0 -5.0 3.0 (of which Mining) 4.0 2.0 2.0 3.0 3.0 Services -3.0 -2.0 2.5 4.0 5.2 Exports of GNPS 2.6 0.8 2.5 4.2 4.3 Imports of GNFS 7.4 5.4 2.0 1.6 1.4 Total Expenditures -3.8 -5.3 -1.6 2.0 3.9 Total Consumption 3.1 -4.2 0.1 3.5 4.0 Private Consumption 18.7 5.5 7.4 7.5 5.6 General Government -10.0 -15.0 -10.0 -3.0 1.1 Gross Domestic Investment -20.5 -8.8 -7.4 -3.3 3.3 Fixed Investment -27.0 -4.0 -3.0 0.0 5.0 Changes in Stocks 10.0 -40.0 -45.0 -55.0 -50.0  - 32 - UZBEKISTAN - BALANCE OF PAYMENTS TABLE II (US$ Millions at Current Prices) Prelim. Projections 1993 1994 1995 1996 1997 1998 A. Exports of Goods & NFS 2e38 3235 3365 3583 3893 4224 1. Merchandise (FOB) 2838 3235 3365 3583 3893 4224 B. Imports of Goods & NFS 3229 3621 3954 4116 4272 4422 1. Merchandise (FOB) 3180 3203 3554 3761 3884 3998 2. Non-Factor Services (Net) 49 418 400 356 368 424 C. Resource Balance -391 -386 -589 -534 -379 -198 D. Net Factor Income -14 -26 -40 -78 -121 -137 1. Factor Receipts 12 91 94 97 96 98 2. Factor Payments 26 117 133 175 217 235 (interest payments) 14 75 84 99 128 153 B. Current Account balance -405 -411 -629 -611 -500 -335 F. Official Capital Grants 0 0 0 0 0 0 G. Long-Term Capital Inflow 1001 418 500 550 481 308 1. Direct Investment 30 120 198 218 240 254 2. Net LT Loans (DRS data) 971 298 302 332 242 54 a. Disbursements 1025 872 660 814 5S86 403 b. Repayments 54 574 358 462 345 349 3. Other LT Inflows (net) 0 0 0 0 0 0 H. Total Other Items (net) 20 30 39 51 66 86 1. Net Short Term Capital 20 30 39 51 66 86 2. Capital Flows N.E.I. 0 0 0 0 0 0 3. Errors and Omissions 0 0 0 0 0 0 I. Changes in Net Reserves -617 -36 90 11 -48 -59 1. Net Credit from the IMP 0 0 140 0 -23 -47 2. Other Reserve Changes -617 -36 -50 11 -24 -12 C- indicates increase) -617 -36 -50 11 -24 -12 Shares of GDP: 1. Resource Balance -1.7 -3.1 -5.1 -4.7 -3.2 -1.6 2. Total Interest Payments 0.1 0.6 0.7 0.9 1.1 1.3 3. Current Account Balance -1.8 -3.3 -5.4 -5.3 -4.3 -2.8 4. LT Capital Inflow 4.4 3.4 4.3 4.8 4.1 2.5 5. Met Credit from the IMF 0.0 0.0 1.2 0.0 -0.2 -0.4 Foreign Exchange Reserves: 1. International Reserves 1299.9 1336.2 1386.6 1375.9 1400.1 1412.1 2. Gross Ree. in Months Imports 4.8 4.4 4.2 4.0 3.9 3.0 Memorandum Item: ODP (Current Million USS) 22999 12338 11570 11374 11650 12162  - 33 - UZBEKISTAN - EXTERNAL CAPITAL AND DEBT TABLE III (USS Millions at Current Prices) Prelim. Projections 1993 1994 1995 1996 1997 1998 A. Disbursements 1. Public & Publicly Guar. LT 1025 872 660 814 586 403 of which Bilateral 837 582 389 272 97 67 Multilateral 0 53 234 263 224 164 of which IBRD 0 4 122 158 159 129 Private Guaranteed 186 237 37 279 266 173 2. Private Non-Guar. LT 0 0 0 0 0 0 3. Total LT Disbursements 1025 872 660 614 586 403 4. IMF Purchases 0 0 140 0 0 0 s. Net Short-Term Capital 20 30 39 S1 66 86 6. Total incl. IMF & Net ST 1045 902 839 864 652 489 B. Repayments 1. Public & Publicly Guar. LT 54 574 358 482 322 303 of which Bilateral 54 233 276 440 313 317 Multilateral 0 12 12 12 12 12 of which IBRD 0 0 0 0 0 0 Private Guaranteed 0 329 70 30 20 20 2. Private Non-Guar. LT 0 0 0 0 0 0 3. Total LT Repayments 54 574 35S 482 322 303 4. IMF Repurchases 0 0 0 0 23 47 S. Total LT Repay.+IMF Repur. 54 574 358 482 368 396 C. Interest 1. Public & Publicly Ghar. LT 14 75 84 99 128 153 of which Bilateral 14 63 78 80 74 65 Multilateral 0 1 4 17 32 47 of which IBRD 0 0 0 9 20 31 Private Guaranteed 0 11 2 2 21 42 2. Private Non-Guar. LT 0 0 0 0 0 0 3. Total LT Interest 14 75 84 99 128 153 4. IMF Service Charges 0 0 0 8 8 6 5. Interest on ST Debt 4 2 4 7 11 16 6. Total incl. IMP & Net ST 16 77 as 115 147 175 D. External Debt (DOD) 1. Public L Publicly Guar. LT 1472 1708 2050 2402 2644 2698 of which Bilateral 1284 1633 1746 1598 1382 1131 Multilateral 0 41 263 514 725 877 of which IBRD 0 4 126 215 442 572 Private Guaranteed 188 34 41 290 537 690 2. Private Non-Guar. LT 0 0 O 0 0 0 3. Total Long-Term DOD 1472 1708 2050 2402 2644 2698 wr  -34 - 4. IMF Credit 0 0 140 140 117 70 5. Short-Term Debt 20 50 89 140 206 291 6. Total incl. IMF & Net ST 1492 1758 2279 2681 2966 3060 E. DOD-co-Exports Ratios (a) 1. Long-Term Debt/Exports 51.6 51.3 59.3 65.3 66.3 62.4 of which Bilateral/Exports 45.1 49.1 50.5 43.4 34.6 26.2 Multilateral/Exports 0.0 1.2 7.6 14.0 18.2 20.3 of which IBRD/Exports 0.0 0.1 3.6 7.7 11.1 13.2 Private Guaranteed/Exports 6.6 1.0 1.2 7.9 13.5 16.0 2. IMF Credit/Exports 0.0 0.0 4.0 3.8 2.9 1.6 3. Short-7erm Debt/Exports 0.7 1.5 2.6 3.8 5.2 6.7 4. LT+IMF+ST DOD/Exports 52.3 52.8 65.9 72.9 74.4 70.8 F. DOD-to-GDP Ratios 1. Long-Term Debt/GDP 6.4 13.8 17.7 21.1 22.7 22.2 of which Bilateral/GDP 5.6 13.2 15.1 14.1 11.9 9.3 Multilateral/GDP 0.0 0.3 2.3 4.5 6.2 7.2 of which IBRD/GDP 0.0 0.0 1.1 2.5 3.8 4.7 Private Guaranteed/GDP 0.8 0.3 0.4 2.5 4.6 5.7 2. IMF Credit/GDP 0.0 0.0 1.2 1.2 1.0 0.6 3. Short-Term Debt/GDP 0.1 0.4 0.8 1.2 1.8 2.4 4. LT+IMF+ST DOD/GDP 6.5 14.2 19.7 23.6 25.5 25.2 G. Debt Service/Exports (a) 1. Public & Publicly Guar. LT 2.4 19.5 12.8 15.8 11.8 11.6 of which Bilateral 2.4 8.9 10.2 14.1 9.7 8.8 Multilateral 0.0 0.4 0.5 0.8 1.1 1.4 of which IBRD 0.0 0.0 0.0 0.2 0.5 0.7 Private Guaranteed 0.0 10.2 2.1 0.9 1.0 1.4 2. Private Non-Guar. LT 0.0 0.0 0.0 0.0 0.0 0.0 3. Total LT Debt Service 2.4 19.5 12.8 15.8 11.8 11.6 4. IMF Repurchases+Serv.Chgs. 0.0 0.0 0.0 0.2 0.8 1.2 5. Interest only on ST Debt 0.1 0.0 0.1 0.2 0.3 0.4 6. Total (LT+IMF.ST Int.) 2.5 19.6 12.9 16.2 12.9 13.2 H. Interest Burden Ratios r 1. Total Interest/GDP 0.; 0.6 0.8 1.0 1.3 1.4 2. Total Interest/Exports (a) 0.6 2.3 2.6 3.1 3.7 4.1 I. IBRD Exposure Ratios 1. IBRD DS/Public DS 0.0 0.0 0.0 1.6 4.1 6.2 2. IBRD DS/Exports (a) 0.0 0.0 0.0 0.2 0.5 0.7 3. Preferred DS/Public DS 0.0 2.0 3.7 5.0 9.4 11.7 4. IBRD DOD/Total DOD 0.0 0.2 5.5 10.6 14.9 18.7 (a) Ratio to 'Exports' with latter defined to include merchandise exports and receipte from non-factor services, factor services and workers remittances.  - 35 - UZBEKISTAN - EXTERNAL TRADE TABLE IV Prelim. Projections 1993 1994 1995 1996 1997 1998 Merchandise Exports - Value (US$ Millions at Current Prices) Cotton 1162 1335 1405 1520 1657 1810 Gas 155 245 275 310 352 387 Gold 547 589 650 719 795 876 Other Exports 975 1066 1035 1034 1090 1151 Total Merch. Exports FOB 2838 3235 3365 3583 3893 4224 Merchandise Exports - Volume Growth Cotton 12.9% 1.9% 3.2% 3.6% 4.5% Gas 58.9% 8.6% 8.9% 9.5% 6.5% Gold 5.0t 5.0% 5.0% 5.0% 5.0% Other Exports -20.0% -6.6% -3.0% 2.3% 2.3% Total Merch. Exports FOB 2.6% 0.8% 2.5% 4.2% 4.3% Merchandise Imports - Value (US$ Millions at Current Prices) Food 632 567 691 730 759 790 Other Con&umer Goods 946 945 1041 1151 1274 1437 POL and Other Energy 493 522 585 570 468 312 Intermediate Goods 315 314 346 383 425 471 (of which Primary Goods) 0 0 0 0 0 0 (of which Manuf. Goods) -315 314 346 383 425 471 Capital and Other Goods 794 855 890 927 957 989 Total Merch. Imports CIF 3180 3203 3554 3761 3884 3998 Merchandise Imports - Volume Growth Food -35.0% 6.7% 2.8% 1.0% 1.0% Other Consumer Goods 0.0% 7.9% 7.8% 7.9% 9.8% POL and Other Bnergy 6.0% 10.0% -5.0% -20.0% -35.0% Intermediate Goods 0.0% 8.0% 8.0% 8.0% 8.0% lof which Primary Goods) .. .. (of which Manuf. Goods) 0.0% 8.0% 8.0% 8.0% 8.0% _ Capital and Other Goods 7.7% 3.9% 3.9% 3.0% 3.0% Total March. Imports CIF -4.1% 7.0% 3.8% 1.2% 0.8%  -36 - UZBEKISTAN - EXTEPNAL FINANCING REQUIREMENTS TABLE V (US$ Millions at Current Prices) 1993 1994 1995 1996 1997 1998 Total Financing Needs (-) -1075 -1022 -1037 -1082 -892 -743 Current Account Balance -405 -411 -629 -611 -500 -335 Non-Interest Current Acc. -391 -336 -544 -512 -372 -182 Interest -14 -75 -84 -99 -128 -153 Changes in Reserves -617 -36 -50 11 -48 -59 Amortization -54 -574 -358 -482 -345 -349 Total Financing Sources 1075 1022 1037 1082 892 743 Foreign Direct Investment 30 120 198 218 240 254 Net Short-Term Capital 20 30 39 51 66 86 Multilateral Financing 0 53 374 263 224 164 of which: - World Bank 0 4 122 158 159 129 - EBRD+IMF 0 49 252 105 65 35 Bilateral Financing 837 582 389 272 97 67 Other (a) 1B8 237 37 279 266 173 (a) Suppliers Credits, Financial Markets, Privately Guaranteed. r  - 37 - UZBEKISTAN - KEY INDICATORS, INTERMEDIATE AND HIGH CASE TABLE VI (high case indicators shown in parenthesis) (USS Millions at Current Prices, except where indicated) 1995 1996 1997 1998 GDP Growth (t) -6.0 -4.5 -2.5 -0.9 (-6.2) (-1.7) (2.4) (4.4) Exports of GNFS Growth (t) -0.1 -0.1 1.0 2.1 (0.8) (2.5) (4.2) (4.3) Imports of GNFS Growth (%) 1.4 -1.8 -1.0 -0.6 (5.4) (2.0) (1.6) (1.4) Current Account Balance -506 -428 -330 -177 (-629) (-611) (-500) (-335) External Capital and Debt Indicators: Total LT Disbursements+IMF & Net ST 734 635 444 350 (839) (864) (652) (489) Total LT RepaymentsaIMF Repur. 358 480 338 339 (358) (482) (368) (396) Total LT Interest+IMF & Net ST 88 108 125 141 (88) (115) (147) (175) Total LT DOD+IMF & Net ST 2174 2329 2436 2447 (2279) (2681) (2966) (3060) Total DOD/Exports Ratio (a) 63.4 65.5 65.4 62.0 (65.9) (72.9) (74.4) (70.8) Total DOD/GDP Ratio 18.8 21.0 22.6 22.9 (19.7) (23.6) (25.5) (25.2) Total DS/Exports Ratio (a) 13.0 16.6 12.4 12.2 (12.9) (16.2) (12.9) (13.2) Total Interest/GDP Ratio 0.8 1.0 1.2 1.3 (0.8) (1.0) (1.3) (1.4) Total Interest/Exports Ratio (a) 2.6 3.1 3.4 3.6 (2.6) (3.1) (3.7) (4.1) IBR: Exposure Ratios: :BRD DS,'Public DS 0.0 1.6 3.2 4.1 (0.0) (1.6) (4.1) (6.2) IBRD DS/Expcrts (a) 0.0 0.3 0.4 0.5 (0.0) (0.2) (0W5) (0.7) Preferred DS/Public DS 3.7 4.9 8.4 10.0 (3.7) (5.0) (9.4) (11.7) IERD DOD/Total DOD 5.8 8.6 10.3 13.9 (5.5) (10.6) (14.9) (18.7) (a) Ratio to 'Exports' with latter defined to include merchandise exports and receipts from non-factor services, factor services and workers remittances.  i. 4 . i I - -4