Public Information Notice No. 08/97

Public Information Notice: IMF Executive Board Concludes Article IV Consultation with Turkmenistan

July 31, 2008

On July 16, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Turkmenistan.¹

Background

In 2007, President Berdymuhamedov launched a program of social and economic reforms. These reforms aim at accelerating growth and diversifying the economy, raising living standards, developing the private sector and a more market-oriented economy, and smoothly integrating Turkmenistan into the international economy. Cooperation with neighboring countries and international institutions is also being expanded. Decisive reforms to the exchange system and administered prices began in early 2008, and steps were taken to attract foreign direct investment (FDI).

Economic conditions remain robust and the outlook for the hydrocarbon sector has greatly improved. In 2007, growth reached 11½ percent, driven by increased hydrocarbon output and broad-based activity in the non-hydrocarbon economy, including the construction, transport and communication, and retail sectors. Inflation was low for much of the year, but started to accelerate in the last quarter, due to higher international food prices and supply shortages caused by the extremely cold winter. Headline inflation in the first half of 2008 was boosted further by the progressive adjustment of administered prices to market levels, with an 8-fold increase in domestic petroleum prices in February 2008, and very large increases in bus and rail fares and airline ticket prices in May and early June 2008.

The fiscal stance has generally been restrained. The 2007 budget surplus amounted to 4 percent of GDP. Revenue growth was only 4 percent, despite the large increase in hydrocarbon exports receipts, due to a change in the allocation of hydrocarbon revenues in favor of off-budget revenue. Expenditure was lower than budgeted, reflecting the slow execution of the investment program. Staff estimates that off-budget operations registered an additional surplus of 11 percent of GDP, with extrabudgetary government spending estimated at about 6 percent of GDP.

Monetary conditions loosened in the last quarter of 2007, but were tightened in early 2008. Credit to the economy grew 30 percent in 2007, reflecting a large increase in directed credits to the cotton sector, partly funded by the Central Bank of Turkmenistan (CBT). As a result, reserve money growth reached 70 percent, and manat broad money almost doubled. However, in the first quarter of 2008, the partial repayment of the agricultural loans and increased sales of dollars contributed to a sharp reduction in both reserve money and manat broad money.

Reflecting the favorable market conditions for hydrocarbon exports, the current account surplus and international reserves grew strongly in 2007. With hydrocarbon export revenues up 30 percent, the current account surplus reached 15½ percent of GDP and gross international reserves rose substantially, notwithstanding a 50 percent increase in imports. The recent growth in FDI inflows, mainly reflecting investments in offshore oil operations in the Caspian Sea, is expected to continue.

The process of exchange rate unification was launched at the start of 2008 and was completed on May 1, 2008. The former dual exchange rate system comprised (i) an official rate pegged at manat 5,200 per U.S. dollar; and (ii) a parallel market rate, 4-5 times more depreciated. Effective January 1, 2008, the authorities devalued the official rate to manat 6,250 per US dollar, and introduced a commercial rate of manat 20,000 per US dollar at which banks could trade freely with the public. Although the transition was originally planned to last for most of 2008, the two markets were unified on May 1, at the rate of manat 14,250 per US dollar, a level consistent with the country's strong external position. At the start of June, the authorities issued new foreign exchange regulations, which allow the CBT to provide ready access to foreign exchange.

The banking sector is small and dominated by state banks, but has grown recently. Prior to unification, direct monetary controls, the predominance of cash as a means of payment, and the distorted foreign exchange market limited the banks' role in the economy. As a result, the level of monetization is low, while a large proportion of commercial bank credit goes to state enterprises, often at relatively low interest rates. The financial soundness indicators indicate banks' general compliance with existing norms. To improve the accuracy of the assessment of the financial sector, a project to introduce International Financial Reporting Standards (IFRS) in the banking system is underway.

Executive Board Assessment

Executive Directors welcomed the impressive economic performance of the past year, driven by higher hydrocarbon export prices and broad-based growth in the non-hydrocarbon economy. Directors commended the Turkmen authorities for taking advantage of the favorable external conditions to launch a wide-ranging program of social and economic reforms. The successful unification of the exchange rates and the adjustment of some administered prices were seen as key initial steps in the process of transforming Turkmenistan into a more market-based economy. Commendable efforts have also been made to increase the country's linkages with neighboring countries and international institutions. Noting that the Government's strategy, which aims at a more diversified economy with a larger role of the private sector, would be important for this integration, Directors looked forward to further progress in this direction.

Directors noted the considerable uncertainties surrounding the assessment of the equilibrium exchange rate, which yielded inconclusive evidence of either undervaluation or overvaluation. They supported the authorities' intention to maintain the stability of the new exchange rate in the near term as a nominal anchor for the envisaged price reforms and currency redenomination, complemented by the strong commitment to allow unrestricted access to foreign exchange for current international transactions, which would help establish confidence in the new system and ensure efficient operations. At the same time, reductions in customs duty and excise rates and nontariff barriers to imports, as well as progress in improving the business environment, will help mitigate the adverse effects of the exchange rate unification on inflation and external competitiveness. Directors recommended that exchange rate policy be kept under review as structural and macroeconomic reforms progress.

Given the recent surge in inflation, due in part to higher international food prices and price reforms, Directors emphasized that a prudent fiscal policy is key to macroeconomic stability. In this regard, Directors commended the authorities' commitment to fiscal prudence despite a comfortable financial position. Directors recognized the need for a moderate increase in budget expenditure to cushion the impact of exchange rate unification and other administered price adjustments on real incomes. In this regard, they encouraged the authorities to develop better targeted social policies, with the assistance of specialized international organizations. While underscoring the importance of prioritizing public expenditures more broadly, Directors welcomed the authorities' readiness to adjust the spending plan if excess demand pressures emerge.

Directors welcomed the authorities' early steps in the implementation of a comprehensive budget reform, with the support of the European Union. They stressed the importance of widening budgetary coverage, strengthening expenditure management and control, and upgrading hydrocarbon revenue management, in order to enhance transparency, fiscal discipline, and project implementation.

Directors underscored the importance of strengthening the monetary framework in support of the new exchange rate. With the increase in headline inflation likely to continue in 2008 as administered prices are adjusted, it will be crucial to tighten the monetary policy stance. In this regard, Directors welcomed the central bank's prompt action to restrain inflation and its commitment to tightly limit its credit expansion and phase out directed credits. They noted that a greater role for market-based interest rates would facilitate the development of market-based monetary instruments and money and foreign exchange markets more generally. Enhancing the independence of the central bank will also be crucial to the reform efforts.

Directors welcomed the authorities' plan to embark on banking sector reforms with a view to promoting private sector development. They looked forward to further progress in developing more efficient foreign exchange and domestic payment systems, strengthening supervision, and bringing accounting and auditing up to international standards. Increasing competition in the banking sector could be facilitated by allowing the entry of reputable foreign banks. Directors welcomed the progress made toward compliance with AML/CFT standards. Moreover, Directors commended the authorities for their efforts to introduce International Financial Reporting Standards (IFRS) in the banking system.

While recognizing the recent progress, Directors noted that remaining weaknesses in data quality continue to hamper effective surveillance. They welcomed the authorities' commitment to improve the compilation of national accounts and price indices with the Fund's technical assistance. Directors encouraged the authorities to improve economic and financial data dissemination through statistical bulletins and other outlets.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.