For more information, see Republic of Tajikistan and the IMF

Enhanced Structural Adjustment Facility–
Policy Framework Paper, 1998–2001

Prepared by the Tajikistan Authorities in Collaboration with
the Staffs of the International Monetary Fund and the World Bank

June 10, 1998

I.  Background

1.  Tajikistan's economic program for the period October 1, 1997 to June 30, 1998, supported under the IMF's provisions for post-conflict emergency assistance, is coming to an end.1 In line with the objectives of that program, significant progress has been made in macroeconomic adjustment as evidenced by the sharp reduction in inflation, stabilization of the exchange rate, and recovery in economic growth. Structural and institutional reforms have also moved forward, although the progress in some areas--most notably privatization--has been less than initially envisioned. To consolidate the significant progress made, the authorities intend to continue sound financial policies and deepen structural reform. In support of these policies, the government is requesting further financial assistance from the IMF under the Enhanced Structural Adjustment Facility (ESAF), and from the World Bank in the form of a Structural Adjustment Credit (SAC).

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II.  Assessment of the Government's Short Term Economic Program

2.  Tajikistan's policy implementation under the program supported by post-conflict assistance was initially mixed. While the fiscal performance was better than expected, slippages in monetary policy resulted in nonobservance of the early performance targets for foreign reserve accumulation and central bank credit creation. Problems in external debt administration led to a failure to meet the targets for debt repayments. However, the authorities took strong corrective action and quickly brought the monetary program back on track and have regularized their relations with most of their external creditors.

A.  Areas of Strong Progress

3.  The major achievement under the program was the progress in macroeconomic stabilization. Inflation declined more rapidly than programmed--from 20 percent per month before the start of the program to an average of less than 1 percent per month so far in 1998. The official exchange rate has remained stable since the beginning of the program, which has helped to bring down inflation and enhance policy credibility.

4.  Real GDP increased about 2 percent in 1997--the first growth since independence. This growth, which was largely concentrated in agriculture, was made possible by two factors: the end of the civil war, and the private external financing of the cotton crop which contributed to an almost 15 percent increase in the cotton harvest for the year.

5.  Key to macroeconomic stabilization was the determined tightening of fiscal policy. Revenue collections were higher and the cash deficit lower than envisaged, and the reduction in budgetary wage and compensation arrears was more rapid than initially programmed. In addition, despite the early slippages in monetary policy--which reflected a failure to collect outstanding loans to the cotton marketing companies according to the programmed schedule--money and credit policies were tightened significantly under the program.

6.  There were also improvements in trade policies during the program. Import duties were unified at 5 percent for all but a few products, as programmed. Excise taxes on imported and domestic products were also unified, while most VAT exemptions for goods imported from non-CIS countries were eliminated. The authorities also initiated the reform of the banking sector. A new Law on Banking has been adopted, minimum capital requirements have been sharply increased, prudential requirements have been strengthened, and diagnostic studies according to International Accounting Standards (IAS) are being completed for the five major commercial banks.

7.  Finally, progress was made in preparing needed amendments to laws which are key to an improved regulatory environment for private business. Amendments to the laws on Collateral, Joint Stock Companies, the Stock Market and Bankruptcy were prepared in consultation with the World Bank and approved by the Spring 1998 session of parliament.

B.  Areas of Weak Progress

8.  The program's initial targets for privatization turned out to be too ambitious, as cumbersome sales procedures and lack of cooperation from local and regional authorities slowed the process. The targets were scaled down in consultation with the World Bank, and a number of steps were taken in March to streamline the privatization process. Since then, there has been an improvement in the pace of privatization of small scale enterprises.

9.  Under the program, the authorities were committed to initiating the process of restructuring key enterprises. The cotton gins were to be separated from the former state cotton-marketing monopoly as a precursor to privatization, and reform of the state-owned electricity company was to begin with the aim of eventual privatization. Progress has been slow in these areas. Similarly, the first steps toward reforming the Tajik aluminum plant (TADAZ) have not materialized, other than preparatory steps for corporatizing the company.

C.  Debt Problems

10.  Significant progress has been made recently in regularizing Tajikistan's external debt. Rescheduling agreements were reached with the Kyrgyz Republic, Turkey, and Uzbekistan, progress was made in talks with Turkmenistan, and the authorities have written China, India, and Pakistan requesting rescheduling of external arrears. Agreements have been reached on more than 90 percent of debt subject to rescheduling, while all non-reschedulable arrears--to the European Union, Kazakstan, Russia and the United States--were cleared. The government of Tajikistan is committed to completing resolving the problem of the remaining external arrears, including to the European Union, as quickly as possible.

11.  The early problems revealed weaknesses in external debt management, stemming from poor information flow within the government. To address this problem, a new debt monitoring and reporting system has been put in place with the support of the World Bank, within which all developments related to external debt will be reported monthly to the new Commission on Foreign Debt, which will be established by end-September 1998. This Commission, which will be chaired by the Minister of Finance, will have sole authority to contract, guarantee or renegotiate external debts.

D.  Policy Implementation Lessons

12.  Strong performance in economic stabilization was primarily the result of clear ownership of the program objectives by the key policy makers, including the President. In addition, the program was endorsed by the United Tajik Opposition (UTO). Strong fiscal performance was facilitated by the recovery of cotton production, with better than envisaged sales tax receipts reducing the need for sequestration. The good revenue performance reduced the need to finance the budget through an inflation tax, thereby helping the central bank to significantly reduce monetary expansion. As a result, confidence in the domestic currency improved and the nominal exchange rate stabilized. The rapid disinflation and recovery of growth, in turn, strengthened government's belief that the economy was on the right track.

13.  The mixed performance in privatization and enterprise restructuring has reflected, inter alia, general governance problems in an unsettled political environment. Initially, this led to lack of initiative with regard to privatization. While small-scale privatization is now gaining momentum, the privatization of medium- and large-scale enterprises has hardly begun. For the same reason, the restructuring of key enterprises in the aluminum, cotton, and energy sectors has lagged behind the program targets.

14.  In view of the short time period of policy implementation, the achievements have been significant. Administrative and institutional capacity, while still weak, has not been a major obstacle for progress in macroeconomic stabilization, although this weakness did contribute to the disappointing progress on structural reforms. Public advocacy of the reforms and recognition of the results achieved has also been inadequate.

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III.  Agenda for the Three-Year Economic Program

15.  Tajikistan's medium-term economic strategy focusses on creating a favorable environment for export-led growth, through promoting private sector development and foreign investment and increasing the efficiency of the agriculture and enterprise sectors. Critical for this strategy is the maintenance of macroeconomic stability. The policy aims at a further reduction in annual inflation to 8 percent during the ESAF-supported program period, and achieving economic growth of 3 to 4 percent per year. It is expected that this growth will be driven by agriculture and agricultural processing--utilizing Tajikistan's low labor costs and comparative advantage in agricultural production--as well as growth in services. Hydropower and mining may also play an increasing role in economic growth.

16.  There is a need to generate significant savings to finance domestic investment, to supplement foreign direct investment and investment financed by international financial institutions. National savings are expected to rise from 1 percent of GDP in 1997 to 9 percent of GDP by 2001; half of this increase will be generated by the public sector. This implies a need for foreign financing of 4 to 4 percent of GDP per year, in order to achieve an increase in the investment ratio from an estimated 7 percent of GDP in 1997 to 13 percent of GDP by 2001. To support private savings, there is a need to keep inflation low, restructure the banking system, shift tax incidence from income toward consumption, and enhance enterprise profitability by, inter alia, restructuring enterprises, pursuing cautious wage policies, and removing tax distortions. The import coverage of the NBT's international reserves is programmed to rise from 0.7 months at the beginning of the program to about 3 months by end-2000, and remain at that level thereafter. Macroeconomic targets of the new program are presented in Table 1, projected developments in income and social indicators are presented in Table 2, and the policy measures which will be implemented in support of these objectives are listed in the attached policy matrix (Appendix I).

17.  Fiscal policy will be the key to success in Tajikistan's economic strategy. The fiscal deficit is programmed to decline from 3.3 percent of GDP in 1997 to 0.3 percent of GDP in 2001.2 The fiscal adjustment needs to be strong in order to boost domestic savings to cover the future external debt service. At the same time, a tight fiscal policy, with declining deficits, will help ensure macroeconomic stability and contribute to growing confidence in the economy. The deficits will be primarily financed by a combination of external loans, treasury bills, and privatization proceeds; no central bank financing of the government will be permitted starting from mid-1999. The government will be cautious in its external borrowing, doing so only on concessional terms and using such financing primarily for capital expenditures, while rigorously adhering to its external debt repayment schedule. The envisaged fiscal adjustment takes into account the need to repair the damage caused by a series of floods and mudslides which struck Tajikistan in May of this year. These natural disasters caused extensive damage to houses, roads, bridges, and crops. The authorities are preparing a repair and prevention program for natural disasters, in a magnitude equivalent to about 1.5 percent of 1998 GDP. This program will be implemented over the next 24 months.

18.  Budget policy will focus on the provision of essential public services in a market economy, as well as increased capital expenditures in the context of a Public Investment Program. In order to fund these services and capital expenditures, the program targets an increase in the revenue to GDP ratio from less than 14 percent of GDP in 1997 to more than 16 percent of GDP in 2001. This task is complicated by the need to replace the sales taxes--which are effectively export taxes--on cotton, aluminum and other products by value added taxation (VAT). This reform will lead to greater reliance on VAT revenues, and require better tax administration.

19.  On the expenditure side, the short-term priority is to address the natural disasters caused by heavy floods and mudslides in May 1998. The implementation of a public repair and disaster prevention program will be extended over the next 24 months and it will contribute to the programed fiscal deficit by about percent of the GDP in 1998 and 1999 but less in 2000. During the program period, the public pension system will be made more effective and its finances strengthened. With arrears on wage and cash compensation payments being eliminated as a prior action, following the 1997 clearance of arrears on pensions, the government will now strengthen its efforts to reform the social safety net. Priority groups for social assistance are non-working pensioners, invalids, and low income families with children under the age of eight. At present, compensation payments are not well-targeted. The authorities are seeking external financial assistance to improve the coverage and timeliness of the household expenditure survey, and intend to review the targeting of the compensation payments system in light of the results of the poverty survey which the World Bank and UNDP will be conducting this summer. They will also work with the staffs of the Fund and World Bank on the design of a new unified social assistance scheme, which would replace the existing numerous forms of social support in 2000.

20.  During the program period, the Ministry of Finance will seek to improve its expenditure management through the completion of the introduction of the treasury system, as well as the improvement of budget preparation and implementation procedures. The IMF will provide technical assistance in the completion of the treasury, and the authorities will seek technical assistance for fiscal policy management as well. A top priority during this program will be to reform the government to make it conform to the requirements of a market economy, and to improve efficiency in the civil service in order to make possible on increase salaries for qualified personnel.

21.  Monetary and exchange rate policies will aim at low inflation and a stable exchange rate. Monetary stability will help strengthen domestic savings and improve the investment climate. To ensure successful implementation of monetary policy, the NBT will improve its short-term liquidity management and enhance its tools for indirect monetary control. Having introduced central bank credit auctions in December 1997, by end-1998 the NBT intends to eliminate refinance credits and extend credit exclusively through these auctions, as well as through the Lombard facility to be developed this year. In addition, they will shortly introduce treasury bill auctions, and will encourage development of an interbank credit market.

22.  The NBT will continue its current asymmetric approach to exchange rate policy. Under this approach, the nominal exchange rate would be allowed to appreciate with market forces, while in the event of pressures for depreciation, credit and fiscal policies would be tightened. The real exchange rate remains largely undervalued, as indicated by low dollar wages compared to other countries in the region, so that the expected real appreciation of the currency through inflation is not likely to cause problems for competitiveness.

23.  To enhance the transparency of operations between the Ministry of Finance and the NBT, during the program period the Ministry of Finance will begin paying interest to the NBT on its new borrowing, and the NBT will pay interest on Ministry of Finance deposits with the NBT, at market determined rates. The NBT will also begin transferring a portion of its profit to the government, in line with the provisions in the Central Bank Law.

24.  Tajikistan's banking system is fragile, and has yet to adapt to the needs of a market economy. As a result, financial intermediation is minimal, which impairs allocative efficiency and growth. Therefore, strengthening the financial sector will be an important element of the new economic program. The NBT will strengthen its efforts to implement the bank restructuring program which has been designed in close cooperation with the staffs of the IMF and the World Bank. Reforming viable banks through operational and later financial restructuring, liquidating non-viable banks, and enhancing NBT banking supervision will increase confidence in the domestic banking system and reduce the high cost of capital.

25.  Structural reforms will be vital for economic growth. The highest priority will be given to privatization of enterprises, collective and state farms, and those farms operating as joint stock companies. Meaningful structural reform requires significant up-front action in several key areas, to support the program's growth objectives. During the first program year, small-scale privatization will be completed, all medium and large-scale enterprises will be registered as joint stock companies, at least 120 medium and large enterprises will be privatized in auctions, and unfinished construction projects and the publicly owned trucking fleet will be sold. A revised Action Plan for the remainder of the program period will be agreed with the World Bank early next year.

26.  Eventually, the government needs to privatize Tajikistan's few large, strategic enterprises. However, significant "passive" restructuring will be required prior to privatization of such enterprises. In the first program year, restructuring plans will be prepared for the state-owned Pakhtai Tajik (the former cotton marketing monopoly) and TADAZ (the aluminum smelter).

27.  A permanent solution to the enterprise sector's problems can only be achieved through a hardening of budget constraints. The government is working with the staffs of the IMF and the World Bank to develop a comprehensive program for addressing the problems of interenterprise, tax and bank loan arrears. While the government has taken some actions to address the interenterprise arrears problem,3 it intends to move further in this area by targeting those state owned enterprises responsible for the largest share of arrears, restructuring or liquidating them, and encouraging the voluntary securitization and trading of interenterprise debts. Recognizing that credits to clear interenterprise arrears, while addressing the problem in the short term, only serve to further weaken payments discipline, the government and the NBT will continue their policy of not extending directed credits or credit guarantees, including to enterprises with significant arrears.

28.  To create a business environment conducive to growth, the legal framework will be strengthened. In order to improve their transparency, several economic laws will be amended, including the Laws on Property, Foreign Trade and Foreign Direct Investment. Equally important will be to ensure fair and efficient enforcement of laws and regulations.

29.  Regarding sectoral policies, the key area is agriculture. The government has established a policy environment that includes liberalized prices, an absence of state orders and restrictions on agricultural imports and exports, and the legal framework for land reform. The supply response to these policies has been muted, however, by the limited progress on land reform. While many state and collective farms have been converted to joint stock companies, they continue to operate as state enterprises, with no improvement in the incentive structure for producers. To accelerate progress on land reform, the government will privatize 60 farms in their entirety during the first program year, by distributing transferable, inheritable land ownership certificates. The government will also develop, in consultation with the World Bank, a timetable for further land reform during the program period.

30.  To strengthen the marketing system for agricultural inputs, the state enterprises responsible for distributing inputs will be privatized. Following the private external financing of cotton inputs in 1997, a number of foreign and domestic investors are providing financing of inputs for the 1998 cotton crop. The government will encourage the development of this model, as well as its expansion to the newly privatized farms. The experience gained from this private financing suggests sustained foreign investor interest, and shows that the participation of foreign capital in the sector's development can be a strong tool for breaking up the monopoly interests that continue to attempt to control cotton processing.

31.  Privatization would enhance the sector's growth prospects and attract additional foreign capital. The government intends to privatize virtually all cotton ginneries during the first program year. During the remainder of the program period, the government will ensure the legal basis and enforcement capacity are sufficient to prevent dominant privatized ginneries from emerging, if such developments are deemed to be anti-competitive. Free entry into the ginning industry will also be ensured. Finally, irrigation systems will be rehabilitated by supporting water user associations among privatized farms and expanding the cost recovery programs for irrigation water, as well as by investment operations being planned by the World Bank.

32.  In hydropower production, Tajikistan would benefit from the development of a regional market with countries that have an electricity deficit, while at the same time supplying irrigation resources for Uzbekistan and Kazakhstan. The hydropower sector suffers from under-investment, a deteriorating supply infrastructure and payment arrears. Apart from measures to enhance payment discipline, as described above, the current low tariffs need to be brought to the level of the long-run marginal cost of producing electricity. Moreover, relative prices are highly distorted, with households and agriculture being charged a far lower tariff than industry. A time schedule has been established to reach full cost-recovery, and significantly reduce cross-subsidization, by the end of the program period.

33.  Tajikistan has vast resources of high-quality coal, and substantial deposits of gold, silver, and base metals, but many of these resources are hard to exploit due to their difficult accessibility. There has already been some foreign investment in the base metal and gold sectors. The government will work with foreign investors to advance joint ventures in this area and ensure that Tajikistan's foreign investment legislation meets international standards.

34.  Although there was considerable investment in physical and social infrastructure in the past, much of this is in poor condition, due to insufficient funds for maintenance and to war damage. The World Bank and other donors, including NGOs, are implementing programs to repair and rehabilitate parts of this infrastructure. The government and the World Bank are also preparing a rural infrastructure project, scheduled to be initiated in 2000.

35.  Enhancing the openness of the trading system will provide a crucial underpinning for the country's growth strategy. Eliminating tax distortions on foreign trade, and maintaining uniform and low import duties, are crucial targets for the program. In the context of the 1999 budget, most of the few remaining import duty exemptions will be removed. As a prior action, the authorities will remove import and export licensing requirements for all goods except those of significance for national defense, health or bio-diversity. Following the abolition of the monitoring of export contracts by the Tajik Commodity Exchange, there are no non-tariff barriers in the trading system. They will also pursue accession to the World Trade Organization, and they intend to accept the obligations of Article VIII of the IMF's Articles of Agreement in the near future.

36.  Systems for fostering human resource development have been severely eroded, as public sector funding for health, education and the social safety net have been reduced. Many social indicators (e.g., the incidence of infectious diseases and school attendance) have deteriorated in recent years. A combination of high recurrent costs (largely salaries) and poorly targeted social programs mean that the delivery of social services is inefficient. The World Bank is preparing pilot operations in health and education that will aid in the restructuring of the service delivery systems in these sectors, focussing on increasing cost recovery, rationalizing public sector institutions, and reorienting the strategies currently used for addressing social problems (e.g., shifting from curative to preventive health care systems).

37.  Current estimates are that the majority of Tajikistan's population is living in poverty. Most of these are in poverty because of the economic collapse, rather than as a result of an inability to participate in the economy. The social safety net that is intended to cushion the impact of poverty is poorly targeted and inadequate. The government, in collaboration with the World Bank and UNDP, is preparing a comprehensive poverty survey for mid-1998 that will provide information on the nature and extent of poverty, as well as the practical impact of the compensation system that is currently in place. The government will use these findings to develop a restructuring plan for the compensation system during 1999. In addition, the World Bank is implementing a pilot poverty alleviation project, and it is expected that this project will be followed by a second operation in 1999, that will build on the lessons of the pilot project. The combination of pilot operations in health, education and poverty alleviation, and the strong government commitment to land reform, provides the foundation for the government's program to alleviate poverty.

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IV.  External Financing Requirements and External Debt

38.  The balance of payments position is expected to remain weak during the program period, largely because significant imports will be needed to alleviate Tajikistan's supply shortages, reconstruct the infrastructure, and help economic recovery from the civil war (Table 3). The current account deficit (excluding official transfers) is projected to decline to about 7.5 percent of GDP in 1998, and further to about 6 percent of GDP by 2001. The capital account (excluding commitments from bilateral and multilateral donors) is projected to record small surpluses throughout the program period. Private sector inflows--particularly foreign direct investment--are expected to increase during the program period.

39.  As the program targets a build up of gross reserves to the equivalent of three months of imports, a substantial amount of financing needs to be identified for the ESAF period. Taking into account repurchases to the IMF, the unidentified average annual financing is estimated at around US$90 million over the program period. For the period of the first annual ESAF arrangement, the financing gap is projected to be largely filled by disbursements from the IMF (60 percent of quota or about US$49 million), and disbursements under a Structural Adjustment Credit from the World Bank (US$50 million). At the Consultative Group meeting in Paris on May 20, pledges for the remaining first program year gap were received from the Asian Development Bank (ADB). Total balance of payments and project support in an amount of US$280 million was pledged for the next 18 months, while humanitarian assistance of US$60 million was pledged for the same period. In the second and third years of the ESAF arrangement, there is a projected financing gap of US$176 million. Expected balance of payments disbursements from the Fund (US$40 million annually), the World Bank (US$40-70 million over the two years) and ADB (US$10 million) will leave a remaining financing gap, to be closed by other donors, of US$16-46 million.

40.  Tajikistan has a very high stock of external debt, close to 100 percent of GDP or about 200 percent of export earnings at end 1997. In light of this, the Government--mindful also of the significant fiscal burden that external debt entails--is committed to strictly limit the buildup of further external public sector debt. During the program period, the Government will limit the contracting of new loans to highly concessional loans and loans from international financial institutions, and limit the issuance of guarantees on external borrowing. The debt buildup of the enterprise sector is also expected to be modest. From 1997 to 2001 external debt is projected to increase from about US$1 billion to about US$1.4 billion and further to about US$1.5 billion in 2003. The relatively large increase from 1997 to 2001 mostly reflects borrowing from the IMF to enable an increase in international reserves and structural adjustment credits from the World Bank to help support the adjustment policies in the public sector. After 2001, public sector borrowing is expected to be limited to what is needed to maintain gross international reserves at prudent levels. As a percent of export earnings, external debt is projected to fall to about 180 percent by 2001 and 160 percent by 2003. As Tajikistan has rescheduled a substantial part of its debt on concessional terms, external debt service in 1997 constituted only 14 percent of export earnings. By 2001, the share of export earnings needed to service Tajikistan's external debt obligations is projected to be about the same (but slightly lower in the interim years) and about 13 percent in 2003.

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V.  Technical Assistance and Statistical Issues

41.  Tajikistan has made significant progress in strengthening the key institutions for economic policy management, but a great deal remains to be done. The authorities are committed to increasing the resource allocation for statistical activities; however, the country will continue to require technical assistance in a number of areas. These areas include bank restructuring and supervision, the treasury system, budget policy and preparation, tax policy and administration, the regulatory environment, and economic data management. In a number of these areas, support has been promised or is being provided by the IMF, the World Bank and others. Appendix I identifies specific areas where technical assistance will be needed and who will be providing that assistance, where that is known. The IMF and World Bank staffs will continue to assist the authorities in identifying sources of technical assistance for the remaining areas.

42.  The authorities recognize the urgent need to strengthen the timeliness and accuracy of key economic statistics, and are thus committed to increasing the resources--including computer resources--available to Goskomstat. They will request technical assistance on national accounts and price statistics to assist them in their efforts to improve their nominal and real GDP data, balance of payments statistics, and key price indices. The immediate priority in this area will be the preparation of reliable quarterly nominal and real GDP statistics.

1The two purchases of SDR 7.5 million each under the post-conflict arrangement were approved on December 18, 1997 and April 1, 1998, respectively. Tajikistan's economic program was also supported by two post-conflict credits from the World Bank of US$10 million each, which were approved on December 16, 1997 and January 29, 1998.
2These deficit targets exclude foreign financed expenditures on the Public Investment Program, prepared in consultation with the World Bank staff.
3Instructions have been issued to all state-owned enterprises requiring them to insist on full prepayment prior to delivering any goods to customers who have arrears to them. Also, Tajik Gas and Barki Tajik now cut off service to customers not paying their current obligations.