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O C C A S I O N A L   P A P E R     
Economic Reforms in Kazakhstan,
Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan

Emine Gürgen, Harry Snoek, Jon Craig, Jimmy McHugh, Ivailo Izvorski, and Ron van Rooden

I   Overview
II   Prereform Setting and Conditions
Ivailo Izvorski

Political Environment
Demographic Characteristics
Resource Endowments and Initial Economic Structures
III   Growth, Employment, and Real Incomes
Ivailo Izvorski and Emine Gürgen

Growth Experience of the Central Asian States
   Growth Performance and Underlying Factors
   The Emerging Private Sector
   Employment and Real Incomes
IV   Fiscal Adjustment
Jon Craig

Role of the Public Sector
Fiscal Adjustment Policies
   Strategies to Reduce Fiscal Imbalances
   The Arrears Problem
   Areas for Further Improvement
V   Monetary Policy and Progress with Stabilization
Harry Snoek and Ron van Rooden

Introduction of National Currencies
Conduct of Monetary Policy
   Macroeconomic Situations Prior to Reforms
   Implementation of Stabilization Policies and Initial Results
   Factors Affecting Money Demand
   Impact of Capital Inflows
Monetary Policy Reforms
   Central Bank Independence and Monetary Policy Instruments
   Interest Rate Policies
VI   External Sector Policies
Jimmy McHugh and Emine Gürgen

External Sector Reforms
   Liberalization of Foreign Trade Prices
   Reform of the Trade System
   Market Diversification
   Phasing Out of Barter Trade
   Currency Reform and Exchange Regimes
Currency Substitution
International Competitiveness
Management of International Reserves
VII   Capital Flows and External Debt
Jimmy McHugh

Breakdown of the Trade and Payments System
Capital Inflows
   Official Financing
   Private Market Financing
   Foreign Direct Investment
External Debt Management
VIII   Structural Reforms
Jon Craig, Ivailo Izvorski, Harry Snoek, and Ron van Rooden

Price Liberalization
Enterprise Reform
   Rehabilitation of State Enterprises
   Privatization of State Enterprises
   Enforcement of Financial Discipline on State Enterprises
   Legal and Institutional Reforms
Financial Sector Reforms
   Evolution and Reform of the Banking Systems
   Bank Supervision
   Accounting System
   Payments System
Fiscal Reforms
   Reforming the Budget Process
   Expenditure Prioritization and Reforms
   Tax Policy and Tax Administration Reforms
IX   Past Lessons and Future Challenges
Emine Gürgen

V   5.1.   Stabilization Policies in the Central Asian States
VI   6.1.   Regional and International Trade Initiatives
   6.2.   Multiple Exchange Rate Practices
VII   7.1.   External Debt of the Soviet Union
   7.2.   Investment and Savings in the Central Asian States
   7.3.   Foreign Investment Laws in the Central Asian States
   7.4.   Equity Markets in Kazakhstan
VIII   8.1.   Progress with Privatization of Nonfinancial State Enterprises
   8.2.   Banking System Reform in the Central Asian States
   8.3.   Method and Costs of Banking Sector Restructuring in the Kyrgyz Republic
I   1.1.   Transition Economies: Selected Indicators, 1997
II   2.1.   Social and Demographic Indicators
   2.2.   Selected Economic Indicators Prior to Transition
III   3.1.   Growth and Inflation
   3.2.   Real Wages
IV   4.1.   Fiscal Indicators
V   5.1.   Introduction of National Currencies
   5.2.   Selected Macroeconomic Indicators
   5.3.   Selected Monetary Indicators
   5.4.   Central Bank Reform and Monetary Policy Instruments
VI   6.1.   Current Account Balances
   6.2.   Exports
   6.3.   Imports
   6.4.   Exchange Rates
   6.5.   Gross Official Reserves
VII   7.1.   Public External Debt
   7.2.   Public External Debt Service
   7.3.   Capital Account Balances
   7.4.   Foreign Direct Investment
VIII   8.1.   Bankruptcy Laws in the Central Asian States
   8.2.   Public Pension Expenditures
   8.3.   Summary of Tax Administration Reform
III   3.1.   Developments in Real GDP
   3.2.   Impact of Inflation and Reform on Growth
   3.3.   Wage Developments
V   5.1.   Monetary Growth and Inflation
   5.2.   Interest Rates and Inflation
VI   6.1.   Trade Balances
   6.2.   Direction of Trade
   6.3.   Nominal and Real Exchange Rates
   6.4.   Gross Official Reserves
VII   7.1.   Public External Debt


I.  Overview

Emine Gürgen

At the outset of their transition to a market economy, the social and economic indicators in the Central Asian states of the former Soviet Union--Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan--generally fell short of the standards of the region as a whole. Notably, per capita incomes ranged from just over 50 percent (Tajikistan) to about 90 percent (Kazakhstan) of the Soviet Union average, while social indicators, such as life expectancy, infant mortality, health facilities, and housing conditions, were considerably worse in most cases. All five Central Asian states--landlocked and distant from world markets--depended heavily on an intricate Soviet system of trade routes and energy pipelines for essential input supplies and exports. Rich agricultural, mineral, and fuel resources of the region, though, made it a potentially attractive outlet for foreign investors. Following a long period of isolation and catering to the needs of the Soviet Union, these countries faced the tough challenge of how to exploit more effectively their natural resources to improve living standards, while simultaneously introducing the systemic changes needed to achieve a market framework and to integrate their economies with the rest of the world.

The Central Asian states have gone part of the way toward meeting this challenge since their independence at the beginning of the decade. There is visible evidence of progress by all five countries toward decentralizing their economies, expanding international links, and intensifying efforts to diversify and increase production and trade. Comparisons with other transforming economies inside and outside of the region, however, indicate that considerable ground still needs to be covered in a number of areas. Notably, the private sector's share constitutes less than one-half of economic activity in most of the Central Asian states, and banking systems (except in the Kyrgyz Republic) continue to be heavily state controlled, while per capita foreign direct investment into the region (except for Kazakhstan) remains relatively low. Also, a set of transition indicators, developed by the European Bank for Reconstruction and Development (EBRD) to measure progress with privatization, enterprise restructuring, price, trade, and financial sector reforms in transition economies, indicates a mixed performance by the Central Asian states, with considerable catching up needed in Tajikistan, Turkmenistan, and Uzbekistan (Table 1.1).

The pace and intensity of reforms have varied widely across the countries in the group. While differences in natural resource endowments, economic structures, and sociocultural factors undoubtedly influenced attitudes toward reform, the two fastest reformers--Kazakhstan and the Kyrgyz Republic--were at opposite ends of the spectrum, in many respects, at the outset of transformation, with Kazakhstan having a much richer resource base and a more diversified economic structure. These differences appear to have motivated each country to move in the same direction, by either taking quick advantage of initial relative strengths (as in Kazakhstan) or by striving to overcome initial limitations (as in the Kyrgyz Republic). By contrast, economic reforms in Turkmenistan and Uzbekistan--which fall somewhere in the middle along the spectrum of resource endowments and output diversity--were, for the most part, more sporadic and came in reaction to events rather than in anticipation of them. In Tajikistan, reform efforts were, until recently, constrained by civil conflict.

The initial years of transition were characterized by sharp output declines and an erosion in living standards in all the Central Asian states. In addition to severe disruptions to input supplies and traditional lines of production, special circumstances such as civil unrest in Tajikistan and an excessive reliance on traditional trade routes--particularly regional energy pipelines--in Kazakhstan and Turkmenistan constrained export markets and adversely affected growth. The negative impact on growth from structural dislocations was further aggravated by high inflation resulting from price liberalization and the monetization of large fiscal deficits to sustain output and employment, notably following the introduction of national currencies. By converse relationship, however, the speed with which inflation was reduced and the depth of structural reforms implemented were instrumental in the recoveries that were initiated during 1996–98. There is evidence in the region that steadfast implementation of stabilization policies in the faster reformers produced, with expected lags, a positive output and investment response by boosting confidence in the economies and strengthening the perceptions of the newly emerging private sectors as to the consistency and sustainability of policies.

Success with stabilization, in addition to augmenting domestic savings, helped attract foreign direct investment (Kazakhstan), which aided the recovery process and brought in much needed capital and technological expertise. Improvements in factor efficiency associated with the reallocation of resources played an important role in the resumption of growth in some cases (Kazakhstan and the Kyrgyz Republic), but was less apparent in others (Turkmenistan and Uzbekistan). Trade liberalization also contributed to growth in the Central Asian states, at first by reinstating steady input supplies and, over time, by improving the efficiency of resource allocation, helping diversification, and ensuring greater transparency in the trade system.

While all the Central Asian countries suffered employment and real income losses during transition, unemployment lagged far behind sharp declines in output. The substantial real wage erosions experienced were partly compensated for by generous consumer subsidies and income from informal market activity, which are not adequately captured in the official statistics. Developments in employment and wages were also influenced by the degree to which countries were willing to restructure their state enterprise sectors. This entailed the imposition of hard budget constraints, notably the phasing out of budgetary support and directed credits to enterprises. In Turkmenistan, Tajikistan, and Uzbekistan, where such restructuring was delayed, open unemployment rates remained correspondingly low, notwithstanding persistent output contractions. Restructuring delays often reflected inadequacies in the social safety net systems to cope with the associated short-term disruptions to employment. Widespread disguised unemployment provided some protection, but at the expense of preventing reallocation of labor to more productive activities.

Given the loss of traditional revenue sources (particularly transfers from the Soviet budget) at the start of transition, the lack of domestic financing from nonbank sources, and limited access to international capital markets, the Central Asian states were left with little choice but to implement major fiscal structural reforms to meet their stabilization objectives in a sustainable fashion. Moreover, many of the reform measures--including price liberalization and exchange rate devaluation--tended to aggravate the fiscal deficits by raising expenditure more than revenue. While all the countries in the region underwent fiscal adjustment during the period reviewed, reductions in fiscal imbalances were accomplished primarily by stop-gap measures. There was heavy reliance on expenditure sequestration and ad hoc revenue measures--particularly in the initial years of transition--and insufficient attention paid to growing payments arrears by governments and state enterprises. Moreover, large quasi-fiscal operations--conducted outside the budget, mainly by the banking sectors--weakened fiscal transparency and management. The adjustments that took place, therefore, represented only the first phase of a more substantive fiscal reform process, aimed at substantially rebuilding revenue and reprioritizing expenditure.

The Central Asian states, following the introduction of their national currencies, intensified efforts to stabilize their economies and sharply reduce inflation from peak rates of as high as four-digit levels. The countries were faced with a choice between adopting exchange rate or money-based stabilization programs. The two main arguments for an exchange rate peg--the instability of money demand during the turbulent transition period and the likelihood of the exchange rate overshooting with money-based stabilization--held sway in the Central Asian countries at the outset of transition. However, the conditions required to make this approach a success (notably restrained fiscal policies and ample international reserves) were mostly absent. Moreover, real shocks, such as sharp terms-of-trade shocks, could not effectively be absorbed if an exchange rate peg was chosen. All five countries, therefore, initially opted for money-based stabilization programs, with some exchange rate flexibility allowed under managed floats. Under these programs, the burden of stabilization fell primarily on fiscal adjustment, which entailed cuts in expenditure (notably real wages, subsidies, and capital outlays) and the tightening of budget constraints on state enterprises. Progress in the latter area varied across countries. Kazakhstan and the Kyrgyz Republic focused attention on state enterprise restructuring early on and eliminated directed credits, while the other countries in the group moved much more slowly.

Despite the absence of an exchange rate peg until mid-1998, considerable disinflation was achieved in all five countries, exchange rates were stabilized or even appreciated in real terms in some cases, and parallel market premiums were reduced (with the exception of Uzbekistan and, to a lesser extent, Turkmenistan). These moves were accompanied by a liberalization of exchange regimes at varied paces, again, with the faster reformers taking the lead. As stabilization took hold, Kazakhstan was confronted with having to protect its economy from destabilizing effects of surges in capital inflows. Protection entailed striking an appropriate balance between further fiscal tightening, sterilized interventions, and exchange rate appreciation. Most countries in the region, however, have not yet faced such tough policy challenges.

The financial crisis in Russia in August 1998 considerably altered the external economic environment for the Central Asian states. The crisis had an adverse economic impact on most of these countries, mainly because of declining Russian demand for their exports. Capital flows were also affected as foreign investors reassessed the risks of financing countries in the region and exchange rates came under heavy pressure. These developments brought to the fore the need to improve external debt management, following a period of sizable accumulated foreign liabilities by the countries, mainly to finance investment at a time of low domestic savings. Also, in countering the impact of the Russian crisis, the Central Asian states were faced with the challenge of resisting the temptation to reverse the exchange and trade liberalization policies already under way. Turkmenistan and Uzbekistan were less successful in meeting this challenge and intensified exchange controls. Other countries combined restrained financial policies with intervention in the exchange market to ward off the pressures on their economies in the aftermath of the Russian crisis.

Progress with structural reforms was mixed among the Central Asian states. All of the countries were relatively quick to initiate price liberalization, although their subsequent paces varied and there were instances of temporary reversals, primarily to guard against social unrest. In almost all instances, controlled prices were maintained for essential foodstuffs, energy, public transportation, and utilities. State enterprise restructuring proved particularly difficult, given the magnitude of the task and the reluctance of the authorities to face disruptions to production and the provision of social services by enterprises. Considerable progress was made in Kazakhstan and the Kyrgyz Republic, though, in initiating restructuring programs and in building the needed institutional frameworks. All countries experienced large domestic payments arrears in their state enterprise sectors, which partly mirrored the phasing out of the traditional sources of finance, such as directed credits, to this still dominant sector.

Privatization also proved to be a daunting task, although the faster reformers progressed considerably beyond the first stage of small enterprise privatization to mass privatization of medium- and large-scale enterprises. Encouraging progress was also made in initiating the privatization of agriculture through land-lease programs and the phasing out of state orders, although privatization of agricultural services fell behind. Legal and regulatory reforms, on the other hand, proceeded in piecemeal fashion, with only Kazakhstan and, more notably, the Kyrgyz Republic undertaking more in-depth reforms of their civil codes. All five countries passed bankruptcy laws at the outset of transition to liquidate persistently loss-making enterprises, although these laws were not rigorously implemented. They also enacted a series of laws to level the playing field for small and large enterprises and to promote competition. Nevertheless, much remains to be accomplished in these countries to achieve a simple and transparent regulatory framework that is fairly enforced.

Recently, the Central Asian states have focused increasingly on reforming their financial systems (both bank and nonbank) as an integral part of their stabilization and reform programs. Banks have not yet been transformed fully from administrators of financial flows to effective intermediaries between savers and investors, so that, again, more progress needs to be made in this area in the next stage of reforms. Also, nonbank financial systems need to be captured in adjustment operations, as is increasingly becoming the case in the Kyrgyz Republic.

Notwithstanding the progress to date, a heavy structural reform agenda remains for the Central Asian states, in order to strengthen their recent stabilization gains and to ensure sustainable and widely shared growth. Deeper and more persistent changes will be needed to improve the quality of fiscal adjustment; rehabilitate or liquidate state enterprises; strengthen banking systems and financial intermediation; restructure pension, health, and education systems; provide more affordable and well-targeted social safety nets; and broaden agricultural and other sectoral reforms. Finally, the scaling back of the still dominant public sectors and the firm integration of these economies into a market framework will require further progress in privatization, as well as continued modification of the extensive regulatory controls already in place. There will also be a growing need to strengthen legal and institutional reforms, as well as to address transparency and governance issues, with a view to limiting opportunities for corruption, enhancing public accountability, and promoting constructive links between governments and newly emerging private businesses.

This paper discusses the broad parameters of the prereform setting in the Central Asian states, including demographic features and natural resource endowments, and their possible impact on the approaches to reform. The paper also reviews the growth experiences of the Central Asian states during transition and finds that, apart from the predictable disruptions associated with transition and special factors such as civil strife, growth performance was influenced by success in achieving economic stabilization as well as by the scope and pace of structural reforms. Fiscal adjustment policies and the role of the public sector are examined, underscoring the desirability of further curtailing state involvement in these economies and of strengthening the quality of fiscal reforms. The experiences of the Central Asian states are also traced with regard to monetary policy reforms and stabilization since the introduction of their national currencies, focusing on the choice between monetary and exchange rate-based stabilization programs. Two sections examine external-sector reforms--including trade liberalization, market diversification, and currency reforms--and capital flows to the region, both in the form of foreign direct investment and official or private financing. Section VIII revisits and expands upon some of the areas covered in preceding sections, concentrating on the structural elements of reform to complement and strengthen the stabilization and growth efforts already under way. The paper concludes with key lessons to be drawn from the reform experiences of the Central Asian states and challenges for the future.

Table 1.1. Transition Economies: Selected Indicators, 19971
(in millions)
Per capita
(in U.S. dollars)
Private sector
(share in GDP)
Foreign trade
(in percent
of GDP)
FDI per capita
(in U.S. dollars)
Asset share of
Average of EBRD transition
Central Asian states 54.7 596 41 43 27 49 2+
Kazakhstan 15.7 1,434 554 31 84 45 3–
Kyrgyz Republic 4.6 366 60 38 18 10 3–
Tajikistan 6.1 179 20 69 2 . . . 2–
Turkmenistan 4.7 390 25 48 23 68 1+
Uzbekistan 23.6 611 45 26 7 71 2  
Russia 147.2 3,056 70 18 25 29 3–
Other CIS 82.1 746 43 32 45 28 2+
Armenia 3.7 435 55 32 14 3 3–
Azerbaijan 7.6 509 40 28 144 81 2+
Belarus 10.2 1,314 20 60 19 55 2–
Georgia 5.4 968 55 14 35 0 3–
Moldova 4.3 504 45 24 15 0 3–
Ukraine 50.9 976 50 35 12 . . . 2+
Baltics 7.7 2,674 67 51 69 19 3  
Estonia 1.5 3,230 70 61 8 0 3+
Latvia 2.5 2,211 60 41 139 7 3  
Lithuania 3.7 2,581 70 50 59 49 3  
Central and Eastern
111.3 3,516 62 38 76 44 3+
Source: Data compiled from European Bank for Reconstruction and Development, Transition Report 1998.
1Other than for population, the group entries represent unweighted averages for the countries in the groups shown.
2EBRD estimates based on conversion of GDP in domestic currency to U.S. dollars using average 1997 exchange rates. The figures should be viewed as broadly indicative only, given the existence of multiple exchange rates and the associated conversion difficulties in some of the countries shown.
3EBRD transition indicators covering enterprise reform, financial sector reform, legal reform, and market and trade reform. Individual indicators range from 1 to 4+, with 4+ indicating the most progress in reforms (e.g., a 2– indicates more progress than 1+ but less progress than 2).
4According to IMF information, private sector share may be closer to 70 percent.