Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 38150 TJ

Public Disclosure Authorized -

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR A SECOND PROPOSED GRANT

IN THE AMOUNT OF SDR 6.7 MILLION

OJSS10 MILLION EQUIVALENT) Public Disclosure Authorized TO

THE REPUBLIC OF TAJIKISTAN

FOR A

PROGRAMMATIC DEVELOPMENT POLICY GRANT

June 15,2007 Public Disclosure Authorized

Poverty Reduction and Economic Management Unit Central Asia Country Unit Europe and Central Asia Region Public Disclosure Authorized

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. REPUBLIC OF TAJIKISTAN

Government Fiscal Year: January-December

Currency Equivalents

(Exchange Rate Effective as ofJune 5,2007)

Currency Unit Tajikistan somoni US$l.oo 3.44 TJS 1.00 0.29

Weights and Measures: Metric System

ABBREVIATIONS AND ACRONYMS

CFAA Country Financial Accountability Assessment CIS Commonwealth ofIndependent States DFID UK Department for International Development DSA Debt Sustainability Analysis EBRD European Bank for Reconstruction and Development GDP Gross Domestic Product IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund MDGs Millennium Development Goals MIGA Multilateral Investment Guarantee Agency MTEF Medium-Term Expenditure Framework NE3T National Bank ofTajikistan PDPG Programmatic Development Policy Grant PEFA Public Expenditure and Financial Accountability PEP Private Enterprise Partnership PPIAF Public-Private Infrastructure Advisory Facility PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper SAC Structural Adjustment Credit SME Small and MediumEnterprises

Vice President: Shigeo Katsu Country Director: Annette Dixon Sector Director: Cheryl Gray Sector Manager: C. Felipe Jaramillo Task Team Leader: R. Sudharshan Canagarajah FOR OFFICIAL USE ONLY

CONTENTS

1. Country Context...... 1 Recent Macroeconomic Developments ...... 2 2 . Tajikistan’s Poverty Reduction Strategy ...... 8 3. Development Policy Program ...... 10 A . Pillar 1: Promoting Private Sector Development 10 ...... (i) Maintaining macroeconomic stability ...... 10 (ii) Improving the investment climate ...... 10 (iii)Regulatory reform in key strategic sectors ...... 13 B. Pillar 2: Public Sector Reform and Improving Public Service Delivery ...... 15 (i) Public sector management reform ...... 15 (ii) Public service delivery ...... 19 4 . Proposed Operation ...... 27 A . Description ofthe Operation...... 27 B. Objectives. Themes. and Policy Areas ...... 27 C . Linkages to Country Partnership Strategy ...... 28 D. Collaboration with the IMF and Other Donors ...... 29 E. Relationship with Other Bank Operations ...... 30 F. Lessons Learned...... 30 5 . Operation Implementation...... 32 A . Poverty and Social Impact ...... 32 Implementation. Monitoring. and Evaluation ...... 34 B. .. C . Fiduciary Aspects ...... 35 D. Disbursement and Auditing ...... 36 E. Environmental Aspects ...... 37 F. Risks and Risk Mitigation...... 39

Boxes Box 1: Governance in Tajikistan: Challenges and efforts to improve outcomes ...... 6 Box 2: Good practice principles on conditionality ...... 32

Tables Table 1: Medium-term macroeconomic outlook ...... 3 Table 2: Dealing with licenses (2006) ...... 11 Table 3: Agreed changes in PDPG 2 prior actions and milestones ...... 22 Table 4: Prior actions and triggers for Programmatic Development Policy Operations 2 and 3 .... 28

This document has a restricted distribution and may be used by recipients only in the performance of their official duties . Its contents may not be otherwise disclosed without World Bank authorization. Annexes Annex 1: Letter ofDevelopment Policy ...... 42 Annex 2: Policy Matrix ...... 69 Annex 3: Link between the Program, Analytical and Advisory Assistance, and other Bank and Donor Programs ...... 79 Annex 4: Relations with the International Monetary Fund ...... 80 Annex Tajikistan Millennium Development Goals.. 5: ...... 85 Annex 6: Tajikistan at a Glance ...... 86 Annex 7: Joint IMF-World Bank Debt Sustainability Analysis (Summary) ...... 88 Annex 8: Linkages between the PDPG operation and the country assistance strategy ...... 100

Map LBRD 33493

The proposed Programmatic Development Policy Grant was prepared by an IDA team consisting of R. Sudharshan Canagarajah, Jariya Hoffman, Utkirdjan Umarov, Tony Verheijen, Svetlana Proskurovska, Khursheda Nazirova, Kathy Lalazarian (ECSPE); Emesto Cuadra, Dina N. Abu-Ghaida, Sarbani Chakraborty, Rekha Menon, Anne Bakilana, Peyvand Khaleghian, Saodat Bazarova (ECSHD); Sudhee Sen Gupta (CICIC); Norpulat Daniyaraov, Naushad Khan (ECSPS); Bekzod Shamsiev, T. V. Sampath (ECSSD); Raghuveer Sharma (ECSIE); Aziz Khaidarov (ECCTJ); Andrea Dall’Olio (IFC); Wendy S. Ayres, Martin Brownbridge, Mehmet Gokay, Marc Sadler, and Firuz Kataev (Consultants). Peer reviewers included Amparo Ballivian (LCCNI) and Sarah Cliffe (OPCFS). The team benefited from the inputs and guidance of Felipe Jaramillo (ECSPE) and Jan Walliser (OPCCE). The team gratefully acknowledges the excellent close collaboration of the Tajikistan authorities, development partners, as well as the support and guidance of Annette Dixon, Cheryl Gray, Cevdet Denizer, and Mehrnaz Teymourian. Damika Somasundaram and Takhmina Jumaeva assisted the team. REPUBLIC OF TAJIKISTAN

Second Programmatic Development Policy Grant Summary

Borrower Republic of Tajihstan

Implementing Agency Government ofTajikistan

Amount US$10 million in IDA Grant.

Terms To be provided as a grant, not subject to repayment.

Tranching USSlO.0 million in IDA Grant will be disbursed in a single tranche following effectiveness. Description The proposed Second Programmatic Development Policy Grant is the second in a programmatic sequence that support the Government’s reform program outlined in the poverty reduction strategy paper. The operation will support a strategc set of policy reforms in private sector development, public sector management and social service delivery. Proposed policy actions ofthis second operation continue with the strong cross cutting emphasis on public and private sector governance. This operation is also very closely aligned with investments and technical assistance programs ofthe Bank and other development partners in related areas. The proposed program is divided into two pillars with the following components: Pillar 1. Promoting Private Sector Development 0 Component 1: Maintain macroeconomic stability. 0 Component 2: Improve investment climate through reform of licensing and inspections, increasing transparency ofthe privatization process and promoting market competition. 0 Component 3: Reform regulatory frameworks by separating policy mahng from regulatory functions in key strategic sectors (aviation, cotton, and energy). Pillar 2. Public Sector Reform and Improving Public Service Delivery Component 1: Public sector management reform through restructuring ofcore public institutions, reforms ofcivil service management and wage system, strengthening of the medium- term expenditure framework. 0 Component 2: Improving social service delivery in health and education.

i Benefits The proposed operation would provide the Tajik government with support to finance some ofthe expenditures associated with the implementation ofa medium-term reform program. Major benefits ofthe overall reform program would be:

0 Improved investment climate.

0 Improved public sector performance.

0 Improved governance. 0 Improved delivery ofhealth and education services. Risks The implementation ofthe proposed reform program faces five major risks related to: (a) weak government implementation capacity, (b) poor governance and corruption, (c) additional non- concessional borrowing by the government, (d) Tajilustan’s complex political economy, and (e) the vulnerability ofthe economy to external shocks. The program contains a number ofmeasures to mitigate these risks.

Operation ID Number PO96930

.. 11 INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAM DOCUMENT FOR A PROPOSED SECOND PROGRAMMATIC DEVELOPMENT POLICY GRANT

TO

THE REPUBLIC OF TAJIKISTAN

1. COUNTRY CONTEXT

1. Tajikistan is a small economy in Central Asia with 6.7 million inhn,,,ants and a per capita income of US$360 in 2006.’ The economy, which grew on average by 9 percent during 2001-06, depends heavily on exports of cotton and hydroelectricity, and on growing remittances of migrants estimated at US$1010 million in 2006 (36 percent of GDP).’ Poverty although declining steadily remains very high. In 2004, 57 percent of the population was living below the purchasing power parity poverty line of US$2.15 a day.3 Social indicators (primary and secondary school enrollment rates, infant mortality, maternal mortality ratio, incidence of tuberculosis, and child malnutrition) deteriorated following independence due to the civil conflict, worsening public service delivery, and weak g~vernance.~They have only recently begun to stabilize and reverse. Tajiktstan is the only country in the Eastern Europe Central Asia Region unlikely to achieve most ofits Millennium Development Goals (MDGs).’

2. While earlier efforts to accelerate structural reforms were hampered by the post-war environment, the combination of sustained macroeconomic stability and economic growth and the recent political consolidation have created the space for more fundamental reform. Concerned about the vulnerability ofTajikistan’s economy to a change in external conditions, the government has outlined a comprehensive program of structural and institutional reform aimed at sustaining growth and reducing poverty. This program, which is being incorporated in the upcoming second poverty reduction strategy paper (PRSP), centers on (a) reform ofpublic sector management, (b) development of the private sector and attracting investments, and (c) development of human potential. A presidential election held in November 2006 returned President Rakhmon, who has been in power since 1992, to office for another seven years. This makes it likely that the policy and structural reform process that the country has embarked upon will continue as planned.

3. The proposed operation is the second in a programmatic series that provides support for reforms aimed at promoting private sector development and improving the delivery of public services. In the private sector, the proposed reforms are improving the investment climate through reforms of the licensing, permitting, and inspections regime; strengthening the legal, institutional and regulatory framework in key strategic sectors (aviation, cotton, and energy); and enhancing transparency of the privatization process. In the public sector, the operation will focus

’ Gross national income per capita, World Bank Atlas method. 2 Aluminum exports that had accounted for more than half of merchandise exports in 2004 are now treated as exports ofservices due to the move to a tolling arrangement. Tajikistan Household Energy Survey (2004). 4 Tajikistan Living Standard Survey (2003). 5 The World Bank, Millennium Development Goals: Progress and Prospects in Europe and Central Asia region, 2005.

1 on improving the quality of public administration, civil service management, public financial management, and the efficiency and equity of social service delivery. Policy actions in private sector development and public administration are addressing the cross-cutting governance issues that are critical for sustaining growth and reducing poverty in Tajikistan. Further details of the program are presented in chapter 3 and the policy matrix (annex 2).

Recent Macroeconomic Developments

4. The government’s pursuit of sound macroeconomic management has successfully stabilized the economy since 2002. Through tight monetary policy and strong fiscal discipline, Tajikistan has been able to reduce inflation from 3040 percent during 1998-2001 to below 10 percent since 2004. However, inflation reached 12.5 percent in 2006--well above the authorities’ target of 7 percent4ue primarily to higher prices of imported energy and a relatively passive monetary stance. The overall fiscal balance (excluding externally-financed investment) was in surplus 2003-06, achieved through improved revenue mobilization and a reduction in interest payments on external public debt. Revenues including grants have increased from 14 percent of GDP in 2000 to 23.4 percent of GDP in 2006, due to increased revenue from income and consumption taxes arising from rapid economic growth, increased imports driven by remittances and inputs required for large investment projects, as well as some improvements in tax and customs administration. In addition, Tajikistan benefited from several successful debt restructuring and reduction agreements reached with key bilateral creditors, notably with the Russian Federation, Pakistan, Iran, and the International Monetary Fund through the Multilateral Debt Relief Initiative. In 2006, increases in capital expenditures amounting to 4 percent ofGDP, an increase in current expenditures of 1 percent of GDP, and lower tax revenues resulted in a widening in 2006 of the fiscal deficit, which was financed by substantially larger grant inflows than originally budgeted (mainly Multilateral Debt Relief Initiative debt relief). The Government plans to maintain an overall fiscal deficit of 0.1 percent of GDP during 2007-09, excluding the externally-financed public investment program. To finance the deficit the government will need to borrow an estimated average 0.9 percent of GDP from the domestic market. External debt stood at 41 percent ofGDP in 2006, down from 124 percent in 2000.

5. Over the short to medium term, Tajikistan’s macroeconomic prospects continue to be positive, with growth expected to stabilize at around 8 percent. After growing at an average of 10 percent since 2001, economic activity slowed somewhat to 6.7 percent in 2005 due to weak export prices for cotton and aluminum and higher import prices for oil and gas. Growth accelerated to 7 percent in 2006, due to the start of a large-scale Russian-financed hydroelectric power project and of the investments financed with Chinese funds, expansion in aluminum processing capacity to meet continued high world demand, recovery in cotton production following institutional reforms, and buoyant inflows of remittances. These factors are expected to continue to support growth of 7-8 percent during the next few years, possibly towards the higher end of the range as a result of the new investments envisaged in key infrastructure areas. Although the somoni depreciated against the dollar by about 6 percent in 2006, the real effective exchange rate has remained broadly stable. Inflation, although averaging an estimated 12.5 percent in 2006, is expected to remain below 10 percent over the medium term with continued tight monetary policy, although some pressures on consumer prices may result from planned electricity tariff adjustments, higher world energy prices, and higher prices of nontradable goods and services due to remittance-related increases in demand.

6. Expenditures are now expected to rise rapidly over the medium term as the government invests in infrastructure and social services, consistent with the PRSP. Infrastructure investments are now expected to be higher than those presented in the PDPG 1 program

2 document, as a result of the government's recent decision to contract a US$604 million loan (equivalent to 21 percent of GDP) with China. The loan will finance (a) the Dushanbe-Chanak road (US$28 1.2 million), (b) the south-north power transmission line (US$267.2 million), and (c) the Lolazor-Khatlon power transmission line (USrS55.2 million). Disbursements started in the second half of 2006 and are expected to continue until 2009. In this new scenario, overall expenditures are expected to increase from 23 percent of GDP in 2005 to 32 percent in 2007. The increase is not expected to result in inflation or an appreciation of the exchange rate, because most of the funds will be used for imports. In addition to the boost to infrastructure investments, spending on health, education, and social protection will rise from 9.0 percent in 2005 to 10.5 percent ofGDP in 2007.

Table 1: Medium-term macroeconomic outlook

Actual Baseline 2006 2007 2001 2002 2003 2004 2005 (est) (est) 2007-10' Gross domestic product, US$ million 1,033 1,197 1,555 2,073 2,311 2,811 3,141 3,648 Real GDP growth, percent 10.2 9.1 10.2 10.6 6.7 7.0 7.5 7.9 Real per capita GDP growth, percent 10.0 8.9 10.0 10.4 4.6 4.9 5.4 5.8 Per capita GDP, US$ 164 186 237 309 338 403 43 1 479 Annual inflation, percent change consumer price index 38.6 12.2 16.4 7.1 7.1 12.5 8.0 8.0 (Millions of USS$) Current account balance -52.3 -42.9 -19.9 -81.6 -57.0 -69.8 -369.8 -298.0 Exports goods and nonfactor services 734.8 799.4 985.0 1,210.7 601.2 667.7 733.6 859.9 Imports goods and nonfactor services 734.8 799.4 985.0 1210.7 1,221.5 1,645.7 2,213.5 2,383.6 Net income -50.7 -56.8 -90.3 -76.6 -74.0 -98.6 -1 13.3 -1 19.3 Net transfers 1 10.5 143.8 227.5 235.7 636.3 1006.7 1,223.4 1345.0 Net foreign direct investment* 9.5 36.1 31.6 272.0 54.6 140.9 70.0 82.8 (in percent of GDP) Current account balance3 -5.1 -3.6 -1.3 -3.9 -2.5 -2.5 -1 1.8 -8.5 Overall revenues and grants 14.9 16.6 17.3 17.9 20.1 23.4 20.7 20.3 Total expenditures and net lending 18.0 19.0 19.1 20.3 23.0 21.7 31.6 28.7 ofwhich: externally funded public investment program 2.1 2.3 2.7 3.1 3.4 3.1 13.3 9.4 Fiscal balance (including externally funded public investment program) -3.1 -2.4 -1.8 -2.4 -2.9 1.7 -10.9 -8.3 Fiscal balance (excluding externally funded public investment program) -1.0 -0.1 0.9 0.7 0.5 0.8 0.4 0.1 Fiscal balance (excluding externally funded public investment program and MDRI) -1.0 -0.3 0.6 0.0 -0.3 -1.5 -2.7 -3.5 Fiscal Balance (excluding externally funded public investment program and grants) -1.0 -0.3 0.6 0.0 -0.3 -4.4 -1.7 -1.2 External debt 98.4 84.4 66.3 55.3 50.4 40.9 46.2 50.5 Debt service due, in percent of export of goods and nonfactor services 20.3 20.2 15.4 39.3 14.0 32.9 18.1 15.6 Memo Items: Exchange Rate 2.4 2.8 3.1 3.0 3.1 3.3 3.5 3.7 rote: 1. 2007-10 weighted averages. 2. Including debt-for-equity swap with Russia (2004) of US$242 million. 3. Including grants. Source: World Bank staff calculations.

3 7. While the projects financed with Chinese funds appear to be economically sound, and once completed should make a lasting contribution to growth, Tajikistan faces new macroeconomic challenges as a result of their The first is the challenge of managing the macroeconomic effects of the construction phase, which may be adding to aggregate demand at a time when the economy is nearing full capacity. Although most of the funds will be used for imports, the pace ofimplementation may still need to be managed to avoid putting undue pressure on prices ofnontradable goods and services (including labor) and to avoid an excessive real appreciation of the exchange rate, which could affect the competitiveness of exports. The second challenge is the need to ensure that the projects have a high growth impact that translates into greater tax collections required to service the additional debt in the longer term. Charges for debt service are expected to double in ten years, which could strain the public budget unless revenues rise accordingly.

8. The deficit dynamics in 2006-08 will be driven in large part by the decision to increase public investment in projects jinanced by loans from the Chinese government. In 2006, externally-funded disbursements for the public investment program are estimated to have reached 13.3 percent of GDP, up from 3.1 percent in 2005. During 2007-09, such disbursements are expected to average 11 percent of GDP per year. Spending on the public investment program expands the broad fiscal deficit, which is estimated at 2.1 percent of GDP for 2006.7 Excluding grants, the overall budget deficit is estimated to have reached 8 percent ofGDP in 2006. In 2007, the overall fiscal deficit is expected to average 11 percent ofGDP.

9. The external account is expected to remain stable over the medium term after the temporary deterioration related to the new public investments. The current account deficit is projected to deteriorate from -2.5 percent of GDP in 2006 to -11.8 percent of GDP in 2007, mainly as a result of continued strong demand for imports associated with the investment projects in infrastructure and hydroelectricity. After the implementation of the projects, the current account deficit is expected to stabilize at -4 percent of GDP starting from 2010,. in line with the situation prior to the disbursements from the Chinese loans.

10. The risk of debt distress has increased since the Board approval of PDPG 1, but debt remains sustainable. A March 2007 external debt sustainability analysis conducted jointly with the IMF shows that Tajikistan’s debt is sustainable, but is at a high risk of debt distres8 Tajikistan has continued to meet its external public and publicly guaranteed debt obligations on a timely basis and to seek relief from its creditors. Since a large share of loans has been provided on a concessional basis, debt service obligations are currently manageable. However, in 2006 Tajilustan contracted debt from China of US$604 million to finance projects in infrastructure and energy. While the debt was contracted on a concessional basis, with a 40 percent grant element, its size (25 percent of GDP) and uncertainty regarding the economic impact of the projects increases risks to debt sustainability. Under the baseline scenario, three of Tajikistan’s external debt burden indicators (net present value of debt-to-exports, net present value of debt-to-GDP,

b Note that the concessional nature of the loan (2 percent annual interest rate, 5 years grace, and 20 years maturity) is within the framework allowed by the Bank’s non-concessional borrowing policy laid out in a paper to the Bank’s Board in June 2006 proposing policies to discourage countries from contracting non- concessional debt that will increase risks ofdebt distress. 7 Excluding IMF MDRI (2006) of 3.8 percent of GDP. This assumes average GDP growth of 8.0 percent, export growth of 11.0 percent and an average current account balance of -1.5 percent of GDP during 2007-11, and maintenance of fiscal prudence and tight monetary policy under a new IMF program.

4 and net present value of debt-to-revenue) are projected to breach policy-dependent thresholds by 2009, following the rapid disbursement of loans from China. By 2026, however, all ratios are projected to be well below the thresholds. External debt service ratios, however, are expected to stay below their thresholds over the entire period. During the projected period, debt service payments continue to be manageable, with the assumption that all ofTajikistan’s external public and publicly guaranteed debt has been contracted on concessional terms.

11. Sensitivity analyses show that adverse macroeconomic shocks would have a negative impact on Tajikistan’s externalposition. In the event of a combined shock (to real GDP growth, exports growth, inflows of foreign direct investment), all ratios would exceed the policy- dependent thresholds by a significant margin. Additional accumulation of new debt, a sharp increase in the international price of energy, and a sudden decline in remittances from Tajiks workmg abroad would also increase the risk that Tajikistan could fall into debt distress. Moreover, should the government under a worse case scenario assume cotton sector debt estimated at US$300 million (estimates of cotton sector debt range from US$90 and US$300 million) then the risks of debt distress rise. (For details of the scenario analyses, see annex 7). Over the medium term, Tajikistan’s growth, exports, and revenue collections will need to grow fast enough to service the growing debt.

12. The Tajik authorities have not yet reached agreement on a program with the IMF, although discussions on a possible Fund program are ongoing. After successfully completing a Fund program under the Poverty Reduction and Growth Facility, the Tajik authorities have requested a Fund program under its new Policy Support Instrument. A Fund program could clearly be beneficial for a country that is among the poorest ofthe region. It would help to ensure that the government maintains a sound macroeconomic framework and manages its external debt prudently. However, the Fund has reservations about the appropriateness for Tajikistan at this time of a program under the Policy Support Instrument, which is targeted primarily to mature reformers. The Fund is therefore proposing that the authorities enter into a staff-monitored program. Discussions are ongoing and agreement on the best approach is expected by June 2007. Until agreement is reached, the Fund will continue its regular Article lV consultations. The Fund has provided the Bank with its assessment ofTajikistan’s macroeconomic framework, and has no major concerns about its adequacy. The Fund has expressed its support for the proposed PDPG 2.

13. A structural transformation of the economy is still needed to broaden the sources of economic growth and reduce the economy’s vulnerabilities to external shocks. Despite some recent diversification of exports, Tajikistan’s economy remains heavily dependent on a few key commodities and trading partners. It is therefore vulnerable to shifts in world demand for and prices of cotton and aluminum, or a slowdown in the economies of Russia or other members of the Commonwealth ofIndependent States (CIS). Any deterioration in these could widen both the external current account and fiscal deficits, and dampen growth. The new investments in roads and in electricity transmission should help in diversifying the economy by providing key infrastructural services to the private sector. The government will also need to continue to implement key reforms to attract significantly higher levels ofprivate sector investment.

14. The presidential elections of November 2006 have led to a reorganization of the central government. The incumbent president having won the election with nearly 80 percent of the vote, issued a decree in November 2006 reorganizing the central government. The reform is largely positive, as it clarifies roles and responsibilities, eliminates some duplications, and separates agencies based on the proper hierarchy of functions (policy development, policy supervision and enforcement, and public service delivery). However, abolition of the State Financial Control Committee, which was in charge of external audit functions, and the

5 accountability framework of the newly separate committee on taxes and customs are concerns. The Bank with other development partners is working closely with the government to ensure that implementation of the reform is as smooth as possible. They are also maintaining a close dialogue with the government to ensure that an independent external audit function is developed in line with international good practice.

Box 1: Governance in Tajikistan: Challenges and efforts to improve outcomes

Governance challenges

The legacy of the civil war in Tajikistan includes a complex political economy that has constrained public sector performance, private sector investment, and social development. In the initial years, the main priority ofthe government was to consolidate peace, and to gain the support of various political groups. Little progress was made to undertake the fundamental reforms to redefine the role ofthe state from central planner and operator ofproductive activities to that of policymaker, regulator, and facilitator ofprivate sector investment. Moreover, few efforts were made to ensure that constitutionally independent institutions ofaccountability, such as the judiciary and the parliament, have the capacity to perform their accountability functions. Civil society organizations, the media, and other nongovemmental entities are also unable to effectively act as institutions ofaccountability, strengthening the checks and balances in society and on government performance. Governance in the fiancial sector is also weak and banking supervision falls well below international standards. State involvement in productive enterprises has resulted in waste, appropriation ofpublic funds for private gain, and inefficient and outmoded industries. Such involvement also creates obstacles for private sector investment.

This has led to poor governance outcomes in Tajikistan. Tajikistan compares poorly with other countries ofthe region on accountability, control ofcorruption, government effectiveness, and regulatory quality according to the Governance Research Indicator Country Snapshot ofthe World Bank Institute. Tajikistan also scores poorly in other major surveys ofgovernance, including Transparency International’s Corruption Perceptions Index, the Global Economic Forum’s Global Competitiveness Index, and the EBRD’s transition indicators dataset. Moreover, surveys undertaken by local firms show corruption to be a problem. For example, about 60 percent ofpeople surveyed in the 2006 survey on corruption in Tajikistan undertaken by the government and UNDP, said that corruption was the main problem in Tajkistan.

Government’s efforts to improve governance

The government is taking action to strengthen governance both to attract private sector investment for growth and to improve the delivery ofpublic services. Important reforms to streamline the licensing, inspection, and permitting process are expected to improve the climate for business. Restructuring the government administration and reforming pay and incentives is aimed at promoting a more professional civil service. Strengthening ofpublic fiancial management-including enactment ofa new public procurement law, strengthening ofinternal audit, reform ofthe tax administration, and improvements in the budget process-should increase public accountability and transparency, and, coupled with other reforms, are expected to result in improved service delivery. Separation ofthe policymaking from regulatory fimctions in the aviation and energy sectors, and privatization ofstate-owned enterprises are expected to improve transparency and accountability in key sectors ofthe economy. A comprehensive assessment of the fiancial sector is the first step in defining a program to address its weaknesses.

Reforms are already producing results. The Governance Research Indicator Country Snapshot indicators indicate that the country made substantial progress in rule oflaw, regulatory quality, control ofcorruption, and government effectiveness between 2000-05. Data from the Business Environment Enterprise Performance Surveys (BEEPS) also shows that Tajikistan has made significant improvements in governance over time, and classifies Tajikistan as a “gradual improver” on governance issues. Tajikistan has also achieved 8 ofthe required 16 HIPC indicators ofpublic financial management, putting Tajikistan in the top quintile ofHIPC countries, according to the IMF. With continued implementation ofreforms,

6 Tajikistan will be able to show continued improvements in governance.

Support of the Bank Group and of other development partners for improved governance

The Bank Group and other development are helping to improve governance in many ways. IFC’s Private Enterprise Partnership program is helping to reform the licensing, inspections, and permitting regimes. The Public Sector Reform Project (fiscal 2006) is supporting government efforts to restructure the public administration, improve incentives for civil servants, and reform the management ofthe civil service. The forthcoming Public Financial Management ReformProject will support reforms offinancial management, procurement, budgeting, auditing, and debt management. The programmatic public expenditure review and two public expenditure tracking surveys (one for health and one for education)-all to be completed in 2007-will provide the basis for further dialogue on the issues. The Cotton Sector Modernization Project (fiscal 2007), Land Cadastre Project (fiscal 2005), and Energy Loss Reduction Project (fiscal 2005) Bank are helping to improve the transparency and accountability ofmajor sectors ofthe economy. Its aviation sector study and cotton sector review have highlighted the problems ofgovernance in these sectors and recommended reforms that are now being implemented. The Community and Basic Health Project (fiscal 2006), and its Education Modernization Project (fiscal 2003) is helping to improve the efficiency and effectiveness ofthe delivery ofbasic public services. A financial sector assessment program, being carried out jointly by the Bank and the IMF, will informthe government ofwhat needs to be done to improve governance ofbank and non-bank financial institutions.

Other development partners are also working to improve governance in Tajikistan. Switzerland, the European Commission, and EBRD are assisting with various aspects ofthe privatization program. Switzerland and the U.S. are helping with the licensing, inspections, and permitting regimes. The European Commission, the Asian Development Bank, and the U.K. are supporting the implementation of aspects ofthe government’s public administration reform strategy and with public financial management. The EBRD is helping Tajik State Airlines develop and implement its restructuring plans. The Asian Development Bank, the U.S. Switzerland, and the U.K. are assisting with improving governance in cotton sector operations. The Asian Development Bank, Sweden, Switzerland, the European Commission, the U.K., and the U.S. are involved with improving the management ofhealth and education services. Additional information on Bank operations and analytical work aimed at improving governance is presented in annex 3.

Support of the PDPG 2 for improved governance

The PDPG 2 supports governance reforms in a broad range of areas. Reforms ofthe licensing and inspection regimes will reduce the demands for irregular payments. Actions to promote transparency in privatization and with encouraging greater competition among enterprises will reduce the opportunities for well-connected elites to appropriate funds for personal benefit. Separation of policy making, regulatory, and operational functions ofstate-owned enterprises in the energy and aviation sectors will increase the transparency and performance ofthe operations. Reforms ofthe institutions governing cotton pricing and grading will strengthen the bargaining power offarmers, which is expected to increase their share ofsales proceeds. Reforms to restructure the public service and to improve the compensation policies for civil servants and for health and education workers will reduce the opportunities and incentives for bribes. Strengthening the budget process, procurement, and internal and external audit will help to ensure that public resources are used as intended. Finally, reforms ofthe policies determining how health and education budgets are fornied and services delivered will reduce the misuse ofpublic funds and improve the services.

7 2. TAJIKISTAN’S POVERTY REDUCTION STRATEGY

15. Tajikistan was the first CIS country to prepare a Poverty Reduction Strategy Paper (PRSP) in 2002, covering 2002-05. The PRSP aimed to increase real incomes, achieve a fair distribution ofthe benefits ofgrowth, and to ensure a rise in the living standards ofthe poorest. It focused on four pillars: (a) encouraging equitable, labor-intensive economic growth, with an emphasis on exports; (b) supporting the efficient and fair provision of basic social services; (c) targeting support to the poorest groups of the population; and (d) improving governance and security. The key weaknesses of the PRSP were its lack ofprioritization and detailed costing of proposed actions.

16. Over the last three years, the Government implemented key elements of the first PRSP, namely, prudent macroeconomic management policy, increasing budget allocations to the social sectors, and initiation of important reform in the delivery of social services. The Government in 2006 continued to allocate a rising share of GDP to health services from 1.3 percent in 2005 to 1.4 percent in 2006. Still, public spending on health in Tajikistan remains the lowest of countries in the Eastern Europe Central Asia Region. The Government approved a health financing reform strategy in 2005 that envisages increased allocations to primary health care and the introduction of per capita funding and fees for services. A basic benefits package was introduced in 2005, although this was later suspended because of problems with pricing of paid services. It is currently being revised for re-introduction under the PDPG 2 on a pilot basis. The government also increased public spending on education from 3.6 percent ofGDP in 2005 to 4.3 percent of GDP in 2006. The use of per capita-based, as opposed to input norm-based, allocations in the education sector is being piloted in five districts as a first step toward increasing efficiency and reducing inter-regional inequities.

17. Tajikistan has developed new long-term and medium-term development strategies. In 2006 the government with support of the donor community initiated the process of developing a long-term vision for the country’s development: the National Development Strategy for 2006-1 5. It also started to prepare its PRSP for 2007-09 to operationalize it. Both strategies address what needs to be done to achieve the MDGs, while also paying attention to the country’s specific development objectives.

18. The PRSP 2007-09 provides for a comprehensive and prioritized medium-term program. The PRSP objective is to promote sustainable improvements in the living standard of the population, in particular ofthe socially vulnerable groups. This will be achieved through (a) improvements of public administration aimed at increasing transparency, accountability, and efficiency of public institutions and at establishing the macroeconomic, institutional, and legal environment for development; (b) promotion of private sector investment, especially in the energy, transport, and cotton sectors; and (c) investments in health and education services, empowering communities for development, and strengthening the social partnership. System transformation, demographic challenges, environmental sustainability, and gender equality are the cross-cutting themes ofthe PRSP.

19. Overall, PRSP proposed financing is situated within a sound macroeconomic and fiscal framework. Financing sources of the PRSP include the state budget, external aid, and foreign direct investment. Overall financing need are estimated to be about US$5 billion, out of

8 which about US$2.3 billion is confirmed.’ The financing gap is expected to be covered through additional external financing for the public investment program and foreign direct investment. Additional external financing for the public investment program is estimated to be US$540 million, out ofwhich US$lOO million is expected to be on concessional terms. This is broadly in line with the external debt sustainability benchmarks (given the current scenarios of the economy’s growth and inflation). The PRSP envisages additional foreign direct investment to total slightly more than US$2 billion during 2007-09, an annual average of about US$502 million. Attracting this level of foreign direct investment will be a challenge, given that inflows have averaged about US$60 million per year during 2005-06, and will require significant improvements in the investment climate.

20. In general the PRSP for 2007-09 meets the expectations of the donor community. The Tajikistan Donor Coordination Council has been actively discussing the strategy with the government’s Coordination Committee on the National Development Strategy-PRSP. The PRSP largely addresses the key expectations that the Donor Coordination Council has communicated to the government. These expectations are that the strategy: (a) isbased on lessons learned fiom the preparation and implementation ofthe first PRSP; (b) is prepared using a participatory approach; (c) is embedded in the government’s policy, decision malung, and budgeting processes, with clear institutional responsibilities for its preparation and execution; (d) reflects the sectoral and cross- cutting priorities ofthe government; (e) is based on an assessment ofpoverty; and (f) reflects the public investment program and the central capital investment program. Allocation of funds for non-wage maintenance and operations costs associated with these two investment programs should also follow the PRSP 2 priorities. The PRSP matrix ofmeasures is expected to serve as the basis for development partner support to Tajikistan.

This reflects the recent public borrowing from China.

9 3. DEVELOPMENT POLICY PROGRAM

21. The government is pursiiingpolicy and institutional reforms consistent with the PRSP to address weaknesses in the private sector environment and pubic sector performance. Taken together, these reforms are key to address the urgent need to diversify the economy, restructure public sector institutions, and improve overall governance. The PDPG program consisting ofthree development policy operations is designed to broadly support this medium-term agenda.

A. Pillar 1: Promoting Private Sector Development

22. To sustain the recent high level of economic growth, Tajikistan will need to continue to promote private sector development by maintaining macroeconomic stability, improving the investment climate, and strengthening the regulatory framework in key strategic sectors (aviation, cotton, and electricity) over the medium and long term. These will stimulate private investment necessary to sustain a higher level ofeconomic growth and reduce poverty.

(i) Maintaining macroeconomic stability

23. The government has pursued sound macroeconomic management since the end of the civil war in late 1997, as demonstrated by the stabilization of the economy and the achievement of high rates of growth. Sound macro management has been underpinned by the successful completion of two IMF programs. The main challenge will be to maintain this stability in an economy that is vulnerable to external shocks due to the narrow export base. In the medium term, however, the external prospects appear stable, with strong world demand projected for Tajikistan’s exports. Remittances are also expected to continue to grow as the Russian economy benefits from high oil and gas prices. The December 2006 changes in Russian immigration laws are not expected to have a significant impact on the number ofTajik migrants or remittances over the medium term. Over the medium term, the government has targeted a fiscal deficit (excluding externally financed public investment) of 0.1 percent of GDP, the maintenance of single digit inflation through conservative monetary policy, and a gradual accumulation of international reserves. Additional resources generated by ongoing tax reform (supported by the JMF), savings from debt service relief, and public sector reforms will allow for an increase in social sector spending and a gradual increase in public sector wage levels, in line with the projected inflation targets. The government’s recent decision to contract a US$604 million loan from China will pose some macro management challenges that the government is aware of and for which the Bank and the IMF are providing advice.

(ii) Improving the investment climate

24. To sustain economic growth over the medium and long-term, Tajikistan will need to further diversify the economy. Realizing the potential, however, will require significant improvements to the private investment climate. Currently, the private sector in Tajikistan must cope with an unclear and overly cumbersome regulatory and institutional framework that stifles competition, increases the costs and risks of doing business, and discourages innovation and risk taking.

25. To address these issues, the government has approved the private sector development strategy developed with support of members of the Donor Coordination Council, and has indicated its intention to start implementing the strategy with support of development partners. It is anticipated that initial efforts will focus on the simplification of the business

10 registration process, increasing the efficiency of custom procedures, and streamlining and simplifying the business license and inspections regime. Details follow.

Reform of Business Licensing and Inspections

26. Licenses. In 2005 the government adopted a new licensing law that reduced the number of activities subject to licensing from some 1,500 to about 113, updated application processing requirements, and harmonized licensing fees. It also adopted a regulatory framework to implement and administer the law. Implementation of this new legal and regulatory framework is being supported by technical assistance from the International Finance Corporation (IFC) Private Enterprise Partnership, the Foreign Investment Advisory Service (IFC-FIAS), and the Multilateral Investment Guarantee Agency (MIGA). However, some of the 113 activities include several subcategories that continue collectively to pose significant barriers to entry. With support ofPDPG 1, the parliament passed in July 2006 legislation amending the current licensing law to further reduce the number of activities subject to licensing to 65 and to streamline the procedures. Under PDPG 2 the government has prepared amendments to other laws and codes to ensure compliance with the new law on licensing; these are expected to be submitted to parliament by mid-April 2007. The government has also adopted new regulations to ensure consistency with the new law on licensing. USAID has partnered with the Bank in support ofthis effort. In addition, in cooperation with the IFC Private Enterprise Partnership program, the government is reviewing the administrative violations code and drafting the necessary amendments to ensure that this code takes into account the above amendments to the respective laws and regulations.

27. The burden imposed by Tajikistan’s licensing regime is now less than that of 28 comparator countries in Eastern Europe and Central Asia and more closely resembles that of OECD countries. Data provided in the World Bank’s Doing Business 2007 report also indicate that Tajikistan’s ranking has improved from 87 to 85 ofthe 175 countries surveyed. A summary of the key indicators for dealing with licenses is provided below in table 2.

Table 2: Dealing with licenses (2006) Tajikistan Region OECD countries Rank 85 of 175 Procedures (number) 18.0 21.4 14.0

Time (days). -, 187.0 242,5 149.5 Cost (percentage ofincome per capita) 154.7 564.9 72.0 Source: World Bank, Doing Business 2007.

28. Permits. In addition to licenses, permits pose a significant cost of doing business in Tajikistan. Experience in other countries shows that the elimination of licenses often le-ads to a proliferation ofpermits. According to a survey carried out by the IFC in mid-2006, the direct and indirect costs of obtaining permits amounted to nearly 4 percent of annual profits of small and medium enterprises. This news has encouraged the government to develop a reform program with the support ofthe IFC Private Enterprise Partnership (PEP) aimed at reducing the burden ofpermits on businesses. The first action towards permit reform-conducting an assessment ofthe impact of permits in use on the cost of doing business in Tajilustan-was initiated in January 2007. The assessment will provide the basis for preparation and implementation of an action plan next year toward reducing the burden ofpermits on business.

29. The Government aims to reduce the frequency, duration, and arbitrariness of inspections. The government under PDPG 1 established new rules and procedures for inspections through a new law on inspections and amendments to the tax code regarding inspections (the amendments were necessary because tax inspections constitute more than 50 percent of total inspection activities). Under PDPG 2, the government has adopted decrees to implement the law on inspections. It has also submitted to the parliament draft amendments to other laws covering inspections to ensure compliance with the new law. The administration has adopted new regulations (at inspecting agency level), distributed manuals and checklists (to provide administrative guidance and instructions for inspectors) to two agencies (fire and sanitation), trained staff, and publicized information through the media about the law, regulations, and new procedures. Future reforms under PDPG 3 will seek to further reduce inspections by moving from a system of 100 percent coverage of the remaining required inspections to a selective risk-based system. Technical assistance for revising and publicizing the new regulations and procedures is being provided through the FC-Private Enterprise Partnership and the Bank-supported Public Sector Reform Project.

30. Under PDPG 2 the government is implementing a public communications strategy. To ensure that the business community and investors are aware of the new laws on licenses, permits, and inspections and to ensure sound implementation ofthese laws, the government is conducting a communications strategy that comprises (a) a public awareness campaign, (b) training of public officials on the new requirements under the law, and (c) periodic surveys of businesses on impact of implementation.

Improve Transparency in Privatization Process and Market Competition

3 1. Privatization. While small enterprises were completely privatized in 2001, medium and large enterprises are still being privatized based on the Strategic Privatization Plan for 2003-07. This plan aims to (a) privatize 446 medium-to-large enterprises through auctions, (b) privatize 102 large enterprises through tenders, and (c) restructure, introduce private participation, or privatize the remaining 37 strategic infrastructure and other enterprises. All those in the first and second groups of enterprises are expected to be completed by end 2007. Over three-quarters ofmedium and large enterprises (about 421) were divested during 2004-06 through auctions and tenders. Another 79 privatizations are planned for 2007. This will complete the privatization of all medium and large enterprises. Restructuring plans have been prepared for the third group, and implementation will start after the plans are approved in 2007.

32. To stimulate lagging demand, the government is committed to assuring potential investors and the public of the fairness of the privatization process. Under the PDPG 1, a random compliance audit of the 2004 privatization transactions was carried out by an independent international auditor to assess compliance with privatization regulations and identify measures to address any weaknesses. The audit revealed a few deficiencies and proposed remedial measures to address them." The state committee for investment and state property management has taken steps to remedy the deficiencies, and posted both the report and the remedial measures taken on its website. A compliance review of 2005 and 2006 transactions is expected to be complete by mid- 2007, and its findings made publicly available. To increase investor awareness and create greater demand for assets being divested, the government under PDPG 1 committed to disclosing in

10 The firm performed a total of 609 checks on 7 transactions. Deficiencies in three transactions were reported. The fmt involves switching the years that specific enterprises would be privatized, an action that was agreed by the World Bank under the Second Structural Adjustment Credit, as long as the total number of enterprises privatized each year remained the same. The second involves firms that did not produce financial statements because they were no longer operating at the time ofprivatization. The SPC has no control over this matter. The third is a failure to publish within ten days the results ofthe tenders for fm. The SPC has taken remedial measures to address this, and is currently publishing the results oftenders within ten days.

12 national newspapers details of past privatization transactions and upcoming asset sales. It published the results ofthe 2005 privatization transactions (sales price, bidders, and winners) in the Naroduaya Gazeta on April 26, 2006. It followed in February 2007 with publication ofthe results of 2006 transactions. To increase awareness of and stimulate demand for the properties to be privatized during 2007, the government is implementing a communications strategy with support from the European Commission.

33. To promote free and fair competition in the marketplace, the parliament enacted in July 2006 amendments to the competition law. In addition, the parliament enacted in December 2006 amendments to the law on natural monopolies. Both are key policy reforms being supported through the PDPG program. The government has also adopted the regulations needed to implement the two amended laws.

34. Government has transferred the enterprise support function to the state committee for investment and state property management, The anti-monopoly agency continues to be involved in pricing issues for natural monopolies, but the government intends to remove this activity from the agency as the infrastructure regulatory frameworks in the country develop. This will be addressed more fully when the regulations for the amended law on natural monopolies are prepared. Currently, the European Union is providing technical assistance to strengthen institutional capacity ofthe anti-monopoly agency.

(iii) Regulatory reform in key strategic sectors

a. Aviation

35. Good progress has been made since June 2006 with aviation sector reforms. The government recognizes the need to reform the aviation sector to reduce the cost and increase the convenience of air travel. Under PDPG 1 the government committed through a letter fi-om the prime minister to the World Bank to separate the policy making function from technical regulation and to separate the airport from the airline by 2008. Under the PDPG 2, the government issued regulations on December 28, 2006 that effectively separates policy making from technical regulation. The (omnibus) regulatory agency for transport, although affiliated with the Ministry of Transport, is independent, with its chairman appointed directly by the president and its budget provided by the Ministry of Finance, not the Ministry of Transportation. The government has also adopted a government resolution on restructuring Tajik State Airlines, which commits to a separation ofairlines, airports, and air traffic control by the end of 2008. A financial review ofthe separate accounts and a comprehensive analysis of the cost structure of the company’s three business entities (airline, airport, and air traffic control) has been undertaken. A realistic timetable for separation of actual operations has been developed together with recommendations to strengthen capacity and the financial viability of each separate entity. The latter includes revision of the structure of fees and charges for airports and air traffic control and marketing strategies. A detailed business development strategy will follow once the entities have been operationally, financially, and legally separated. These actions together will ensure that the costs and profits of the various operations of Tajik Airlines are transparent and create opportunities for other airlines to enter the market. The EBRD is coordinating its own support with that ofthe Bank to maximize the effectiveness ofboth programs in encouraging reform.

36. To provide time for the Tajik State Air Company to modernize and improve its competitive position, the Government will allocate in a phased manner new and additional route rights over a period of three years. The Government in 2006 licensed two additional international carriers to provide services to Dushanbe, a Russian airline (from Moscow) and in Turhsh Airlines

13 (from Istanbul). The government authorized in November 2006 Turkish Airlines to operate a second weekly flight between Istanbul and Dushanbe. Air Arabia, the new airline of Sharjah (United Arab Emirates) has also expressed interest in operating flights to Dushanbe.”

b. Cotton

37. Tajikistan’s agriculture is dominated by a cotton sector that suffers from substantial domestic inefficiencies and inequities. Today, the Tajik cotton sector, traditionally, its most important agricultural product, is facing significant challenges. The cotton sector’s crucial role in the Tajik economy derives not only from its contribution to the value of agricultural output (60 percent), export earnings (15 percent), and tax revenue (35 percent), but also its support to the welfare of rural population (75 percent) and uses of irrigated and arable land (50 percent of irrigated arable land). Inefficiencies in cotton production are impeding rather than enhancing growth in agricultural production and rural poverty reduction. Rural poverty is highest in cotton growing areas. Growth and productivity, while increasing slowly, are low. Yields are currently around half of their pre-independence levels, and only 55 percent of yield required for reasonable profits. Some 250-350 person hours are required to produce 1 ton of seed cotton in Tajihstan, more than four times the internationally competitive level.

3 8. Recognizing the challenges, the government finalized a Cotton Sector Reform Strategy in early 2005. The first part ofthe strategy proposes immediate measures to resolve the current farm debt overhang (estimated in a range of5-10 percent ofGDP). These efforts are being supported by the World Bank under an ongoing cotton sector project, the Asian Development Bank, DFID, and other donors. The strategy proposes to (a) revise the pricing and contracting systems, (b) encourage alternative sources of financing for agnculture, (c) abandon the practice of local authorities of setting cotton production targets, and (d) create the necessary framework for increasing and encouraging competition in input markets.

39. Implementation of the strategy, with support of the PDPG program and other donor- supported initiatives, has been progressing satisfactorily. The Government and its development partners have produced a roadmap and timetable for implementing the strategy that includes responsibilities ofboth the authorities and the partners. Actions ofthe roadmap are generally being implemented on schedule. The Government, under the PDPG 2, issued an internal regulation introducing a new cotton pricing method (methodica) for calculating the ex-gin price in Tajikistan to replace all other pricing methods. The revised cotton pricing rules will allow farmers to register contracts based on negotiated prices that are not based on production contracts with input creditors. The reformed pricing framework will also allow farmers to register contracts with forward prices (on the date ofthe contract), rather than at delivery ofcotton, thus shifting the risks offalling prices from farmers to buyers (of course, buyers will benefit from rising prices, not farmers). The World Bank will work closely with the Asian Development Bank and others to support the government in implementing the new methodica pricing method.

40. The government under PDPG 2 has also issued a resolution introducing the use of universal cotton grading standards. To implement the new standards, the government has entered into a joint venture with an internationally recognized U.K.-based cotton grading firm, Wakefield, to grade cotton. The joint venture-which is 70 percent owned by Wakefield and 30 percent owned by the government-has submitted an application to Tajik Standard for accreditation of both the firm and its laboratory to grade cotton. The joint venture will initially grade cotton in accordance with existing standards. It will grade cotton using universal cotton grading standards once

11 Tajik Air now flies once a week from Dushanbe to Sharjah and once a week from Dushanbe to New Delhi.

14 legislation introducing these is enacted in 2007 or 2008. The Asian Development Bank is assisting the government with technical assistance to amend current legslation and to procure laboratory equipment and other supplies needed to introduce the new standards.

c. Electricity

41. The government has made goodprogress under the PDPGprogram in implementing the energy strategy. It raised electricity tariffs in early 2007 and plans to continue doing so each year through 2010 until tariffs reach cost recovery levels. The Government increased gas tariffs in October 2006 and again in 2007 in line with increases in prices of gas imported from Uzbekistan. Budget allocations to compensate vulnerable groups for the increased tariffs were increased by 19 percent in the 2007 budget over what was spent in 2006. The dialogue to ensure that the measures are effective is being carried out by the Bank’s energy and social protection specialists. Financial and technical assistance has been mobilized with support from the Bank and the Swiss government to reduce commercial losses in the electricity and gas sectors. The legal, financial, and physical separation of functions between Bark Tajik and the Ministry ofEnergy was initiated in April 2006 in accordance with a presidential decree. Implementation is progressing well. Reforms will be carried out through the Bank-supported Energy Loss Reduction Project.

B. Pillar 2: Public Sector Reform and Improving Public Service Delivery

42. The Government is committed to implementing public sector reforms to improve the effectiveness of the administration. The government adopted on March 16, 2006 a comprehensive public administration reform strategy. The strategy covers restructuring ofgovernment institutions, civil service reform including wage reform, local public administration, and public financial management. The strategy has a long-term timeframe and short and medium-term action plans. The government has begun to implement the strategy’s short-term measures, including restructuring of selected government institutions, and sectonvide reforms in health and education to improve the access to and quality of public services. The medium-term strategy and plans are described in greater detail below.

43. The Bank through the Public Sector Reform Project (approved in July 2006) is supporting the implementation and monitoring and evaluation of the public administration reform strategy. The operation will support selected measures to rationalize core public administration structures and reform the civil service management and wage system. In addition, the proposed Public Financial Management Project, currently under preparation, is expected to contribute to improved public financial management by supporting the implementation of the medium-term expenditure fkamework (MTEF), modernizing core treasury functions and operations, and streamlining financial reporting.

(i) Public sector management reform

44. The Government is reforming its system of public sector management. The Government’s 2006 public administration reform strategy provides the basis for the rationalizing the government structure and increasing the effectiveness of the public administration through better delineation of authorities. Through reorganization of the public service over the medium term, the government will (a) define the register of functions, (b) develop the template for the new organizational regulations of the ministries and other types of public bodies, and (c) draft the regulations that will establish the linkages between the institutions in the structure.

15 a. Rationalization of Core Public Administration Structures

45. The authorities intend to complete the rationalization of the government structure over the medium term. The Government completed the horizontal functional review of the central bodies ofthe executive in January 2007. The review resulted in the compilation of a catalogue of the central government functions, recommendations on refining the missions and functions of the central bodies, and identification of the functions that should be outsourced, terminated, or reallocated. The functional review also presented a methodology for allocating functions and competences. The Public Sector Reform Project will support implementation ofreforms based on the review once the government has taken the key decisions.

46. The government has initiated a restructuring of the central government administration. The president’s decree 6 (November 30, 2006) introduced a new government structure that was implemented during December 2006-January 2007, thus changing the organizational set up of the central public administration. The announced reorganization is generally consistent with the conclusions and recommendations ofthe horizontal functional review. It adheres to the principles ofseparating the policy function from control and service delivery by introducing a two-tier central government system ofpublic bodies. It also reduces the number ofministries and state committees directly subordinated to the government.

47. The uniform implementation of the functional separation to improve the effectiveness of the public administration will require a legal basis on the structure of public administration. Legislation will establish the core principles and norms regulating the institutional system ofpublic administration and define the principles of organization, the types of government entities, their hierarchical status, and the accountability arrangements. A working group reporting to the executive office of the president will be established through a decision of the president to develop the concept for the structure of the public administration and measures for its realization. Specifically, the working group will develop and submit for approval by the executive office ofthe president a time-based action plan that includes the stages of(a) analysis of the current situation, (b) development of proposals for the structure of public administration as well as reporting and accountability arrangements, (c) public awareness measures, and (d) development of a concept and measures for its realization.

48. As anticipated, the recent reorganization of the central government has had some problems. The State Financial Control Committee, which was developing its functions as the Supreme Audit Institution with the support ofa grant from the Institutional Development Fund, has been restructured and its functions have been given to the newly created State Financial Control and Anti-Corruption Agency. This agency has also absorbed the functions of the tax police and the functions of the various law-enforcement agencies previously involved in the fight against corruption. Although Government’s intention was to strengthen the role of the state financial control function, international good practice calls for establishing a tmly independent external audit function that provides independent views on the quality of public sector management. The government has therefore decided to develop an independent audit function in line with international good practice. Abolishing the Ministry of State Duties and Revenues and creating two committees on taxes and customs is also problematic. The Bank is advising the government to clarify the accountability framework of the two agencies, and to bring the function of tax investigation under the tax committee.

49. The Government will face challenges in implementing the new organizational structure. To achieve internal coherence, clear lines of accountability, and good coordination across organizations, the process of reorganizing the executive branch must be carefully managed and

16 slowly phased in over 1-2 years. Effective and timely use of technical assistance from the Public Sector Reform Project during the implementation period will be crucial in mitigating risks.

b. Civil Service Reform

50. Civil service wage reform is being implemented as planned. In agreement with the Bank, the Government is reforming public sector wage policy, aimed at linking rewards to performance and at creating improved career and earnings prospects for public officers. Under PDPG 1, it introduced in November 2005 a new wage system on a pilot basis that (a) integrated all bonuses and allowances, (b) decoupled the calculation of the incremental wage for qualification ranks from the minimum wage, (c) introduced in a phased manner decompression of wages to better reward those that hold positions of higher complexity and responsibility, and (d) changed the status oftechnical staff in the ministries to contract staff. The government rolled out the new wage system to all central ministries on April 1, 2006. This is a significant step toward building a professional civil service, although full implementation is expected to take a total offour or five years.

5 1. The Government is committed to implementing additional wage reforms over the medium term. Following the first step to differentiate pay increases undertaken under the PDPG 1, the government will implement on April 1, 2007 the second stage of reform that will increase the decompression ratio to 1:4 between the salary of deputy minister and that of specialist. The government plans to introduce on January 1,2008 a new central wage model (based on categories, bands and steps, and integrating a years of service component) and the third step in decompression, which specifies a 1:4 decompression ratio between specialist and head of department. Finally, it plans to incorporate on January 1,2009 most benefits and nonwage spending into base salaries.

52. The parliament enacted in March 2007 a new civil service law. The new law addresses many of the weaknesses of the 1998 law, including provisions to clearly separate political from administrative appointments, introduction of competitive, merit-based selection of administrative officials, a simplified grading structure, incentives for performance, and a strengthened role for the civil service department in the management and supervision ofthe civil service. However, the law still does not comply with international best practice. The government plans to undertake several activities under the Public Sector Reform Project to raise awareness ofthe further changes required to attain best practice.

53. Upon approval of the draft law on state service, subsidiary regulations need to be developed and the capacity of the civil service department to monitor the implementation of this legal framework needs to be strengthened. Established in 2001, the civil service department is now almost fully staffed. However, the department still requires significant capacity building. A restructuring plan prepared for the agency in 2005, which aims to strengthen its power and capacity, is being considered by the government. The Public Sector Reform Project is assisting with the review ofits horizontal and vertical functions, and with other measures aimed at building capacity.

54. The Government is implementing the agreed PDPG policy actions related to competitive recruitment and the introduction of a computerized civil service register. The government adopted in 2005 regulations on competitive recruitment and established the civil service register-a key tool for merit-based management of human resources. The civil service department has drafted the government regulation on merit-based recruitment and promotion, which is generally acceptable to the Bank. Government approval of the new regulation is expected by early April. Once approved, the civil service department through seminars and workshops will inform stakeholders on how it will be implemented. The civil service department has also produced recommendations for preparing the job descriptions that will provide the basis for merit-based selection. Further training

17 of personnel managers is planned to improve capacity to implement merit-based recruitment throughout the civil service. The computerized civil service register will have to be designed on the basis ofthe new job classification system and wage gnd for civil servants, and has been postponed to 2008, the third year ofthe agreed program.

c. Public Financial Management Reform

55. The Government has enacted a modern procurement law. A grant from the Bank's Institutional Development Fund is supporting development of a regulatory framework and helping to build capacity of the public procurement agency and other procuring entities to implement the new decentralized public procurement system. In addition, the public procurement agency is developing standard bidding documents and an implementation manual, expected to be adopted in February 2007. Unfortunately, the law "on bidding" creates confusion that may lead to misinterpretations in implementation of the new law on public procurement. The Ministry of Economic Development and Trade has submitted a draft resolution to repeal the law to the internal governmental coordination process for review. It is expected that the resolution will be adopted by the end ofMarch 2007.

56. The Government has adopted standard bidding documents in line with international good practice. The Bank has provided initial comments on the Russian version. The Government plans to submit the English version to the Bank for review by the end ofMarch 2007 and to adopt the standard bidding documents, once it incorporates comments ofthe Bank.

57. The Government is introducing an MTEF beginning with a pilot sector. The Government formally endorsed the introduction of the MTEF by issuing in September 2006 a government resolution on the MTEF. The Ministry of Finance issued MTEF instructions in December 2006 that specify the changes to the budget process that will take place under the MTEF reform program. The MTEF will be introduced gradually, starting in 2007 with a pilot covering the education sector. Introducing the MTEF will require radical restructuring of the budget processes to give the line ministries-currently marginalized in the process ofdetermining budget allocations in their respective sectors-a central role in the budget process, with responsibility for coordinating and directing budget allocations for all budget organizations in their respective sectors consistent with an aggregate sector ceiling determined by the Ministry of Finance. Due to capacity constraints, the Ministry of Finance will not prepare budget strategy papers during the next two years, as originally foreseen under the program. Instead it will prepare and publish budget execution reports that also compreheusively analyze implementation of the budgets of the sectors covered by the MTEF. Development partners (European Commission, DFID, World Bank, Asian Development Bank, and IMF) intend to support strengthening ofbudget management and an MTEF to improve predictability ofthe budget and ensure pnority and efficiency ofpublic spending.

58. Developing an education sector strategy for the MTEF will require challenging changes in the education budget preparation process. Currently, local government authorities submit their education budget requests and negotiate budgetary allocations directly with the Ministry ofFinance. The Ministry of Education plays a limited role in the process. In the context of the MTEF the Ministry of Education will have the responsibility ofreviewing budget requests submitted by local governments. This will pose several challenges. First, the local government authorities may resist the involvement ofthe Ministry ofEducation in negotiating with the Ministry ofFinance. Second, the Ministry ofEducation may lack capacity to reconciling education policy and budgeting. Given these challenges, it is proposed that the MTEF for education be introduced gradually over three years (2008, 2009, and ZOlO), and that the process begin with the inclusion of the Ministry of Education in the 2008 budget negotiations that commence in April 2007. Development partners,

18 including DFID, UNICEF, and the Fast Track Initiative will provide technical assistance and training in the Ministry of Education to enable it to fully implement the MTEF by 201 1. The Fast Track Initiative Catalytic Fund already supports strengthening of fiduciary capacity of the ministry to manage external funds. These issues are covered under the programmatic public expenditure review.

59. The government is committed to strengthening internal financial control. The government adopted through a resolution the public internal financial control strategy in March 2007. This strategy is compliant with international standards, and includes the decentralized internal audit approach and methodology, structural and institutional arrangements, and staffing and skills requirements. The European Commission will assist the government to develop new and amended legislation related to public finances and financial accountability and to strengthen audit capacity at the central and the local government levels.

60. An independent external audit function needs to be developed. The Bank and other development partners have conveyed their concern to the government that the recent government restructuring has weakened the country’s independent external audit function. The government has confirmed its intention to develop an independent external audit function through the Letter of the Development Policy (annex 1). This will include developing the legal framework to strengthen the independent audit function and introducing the necessary amendments to the law on state financial control to streamline its functions and those of the State Financial Control and Anti-Corruption Agency. In parallel, the necessary changes will be introduced to the draft institutional development plan to strengthen capacity to carry out the external audit function. The Bank will work with the government to identify an appropriate model for developing an independent external audit function based on the various models and experiences of other countries. As an interim next step, the President of Tajikistan has issued an internal order that establishes a task force responsible for identifying the options for an independent external audit function. PDPG 3 will include as a trigger a policy action developing an independent external audit function. The Bank will support the reforms through the Public Sector Reform Project and the proposed Public Financial Management Modernization Project.

61. The Government has launched under the Programmatic Public Expenditure Review, public expenditure tracking surveys of spending in the education and health sectors, aimed at ensuring resources are used as intended. The public expenditure tracking survey for health was launched in November 2006, and the one for education started in April 2007. Dissemination of findings from the analyses will take place in the third year ofthe program.

(ii) Public service delivery

a. Primary Health Care

62. In May 2005, the Government adopted a national health financing strategy, based in part on an earlier health policy note prepared by the World Bank. The strategy aims to improve fiscal sustainability, transparency, and accountability in the health sector. The financing reform measures agreed under the PDPG operations include (a) the allocation ofa greater share ofwage increases to primary health care workers, (b) the reintroduction ofbasic benefits package, (c) the introduction of a new job classification and wage grid system for primary health care workers, and (d) the separation of funding flows and accountability mechanisms between primary and secondary care. Once these reforms are initiated, the government will introduce per capita allocations in primary health care in two phases on a pilot basis. The Ministry ofHealth adopted in March 2007 a newly designed per capita financing plan. In the first phase ofimplementation, to be implemented during

19 2007, funds will be pooled at the rayon level in six pilot rayons (Nurek, Asht, Spitamen, Sarband, Shurabad, and Kabodiyon). In the second phase, to be implemented during 2008, funds will be pooled at the oblast level.

63. Implementation of the policy actions to be supported under the PDPG program is largely on track, with slippages in some planned reforms. Sixty percent ofthe increase in the 2006 budget for the health sector wage bill went to primary health care workers, and the remainder went to hospital care in the first year of the program. The government planned to allocate 80 percent of health wage bill increases to primary health workers in all rayons during the second year of the program.I2 However, due to political challenges, it will instead allocate 54 percent of the increase in the wage bill to primary health care workers, and 46 percent to others. This translates into a 30 percent increase in wages for primary health care providers and a 10 percent increase for others. The wage increases became effective April 1, 2007. Introduction of a new job classification and wage grid system for primary health care workers has been delayed, and will now be supported under the third phase ofthe PDPG rather than the second phase.

64. The introduction of the basic benefit package, including free essential health services and co-payments for other services (including hospital care), will be implemented in pilot rayons instead of in one oblast as originally planned The government lifted the suspension ofthe basic benefits package and tasked the ministries of finance and health with ensuring its reintroduction in 2007. During the PDPG 1, it initiated the preparatory work necessary for the reintroduction ofthe basic benefits package and under the PDPG 2 it originally envisaged the reintroduction of a fully- funded basic benefits package in one oblast on a pilot basis and integration of the basic benefits package into hospital budget for that oblast by November 2006. It envisaged implementing in 2008 the basic benefits package nationwide. However, due to weak capacity, the government subsequently decided to implement per capita health financing into two phases beginning with the rayon level. Therefore, the basic benefits package will be reintroduced on a pilot basis in the same six rayons as that of the per capita financing in 2007. The basic benefits package will also be integrated into the hospital budgets ofthe pilot rayons.

65. Nationwide rollout of the basic benefits package will be delayed until a thorough assessment of the pilot can be conducted. The government recognizes that reintroducing the basic benefits package, including formal copayments, will only succeed through deliberate, step-by-step implementation linking its reintroduction with other reforms ofhealth financing, including changes in provider payment systems. It will therefore carry out an assessment of experience in the pilot rayons prior to reintroducing the basic benefits package more widely.

66. The Government has established a timetable for phasing the implementation of co- payment, clarified its structure, and agreed on the definition of co-payment. In phase 1 in 2007, the government will introduce a single co-payment system that will apply for hospital care and outpatient diagnostic tests. The system will be simple and clearly understood, and can be revised and diversified over time by oblast or rayon. There will be no more than 10 co-payment categories. The basic benefit package currently includes free outpatient consultative visits and free primary health care visits. However, both will need to be reassessed in the future. The Government recognizes that it will need to revise the structure ofprivileged categories-a combination of social groups, age, and diseases covering about 40 percent of the population-to ensure fiscal sustainability, and plans to do so in 2007, prior to implementation of phase 2. The World Bank- supported Community and Basic Health Project will support the government in its effort to revise the structure and categories ofprivileges.

*’ An increase in total public sector wage bill for the health sector for the 2007 budget is 15 percent.

20 67. Challenges remain in addressing several key issues to ensure successful reintroduction of the basic benefits package and subsequent implementation of the per capita budget. The Ministry ofHealth needs to take several actions. First, it needs to issue an instruction regarding the reintroduction of co-payments under the basic benefits package to the pilot rayons. Second, it needs to separate nationwide the budgets for primary health care and hospital care. Third, it must establish the director position of the primary health care network in central rayon hospitals in pilot rayons. Finally, it needs to finalize and approve the per capita methodology to be used in the pilot rayons, and approve the legislation on hospital autonomy by September 2007.

68. The proposed operation complements other projects in the health sector. The World Bank-financed Community and Basic Health Project (Board approval was December 2005), the Public Sector Reform Project and projects supported by other donors (USAID-financed Zdrav++ Project, Swiss-financed Sin0 Project, Asian Development Bank-financed Health Sector Reform Project) will provide the necessary support for capacity building, monitoring, and implementation ofthe reforms supported through the proposed operation.

b. Education

69. In 2005 and 2006, a system of per capita allocations was implemented in the schools in five pilot rayons. A review of pilot 2005 implementation found three shortfalls: (a) the education budget ofthe pilot rayons was formed on an input-based principle, (b) the formula for allocation of funds to schools was not appropriate, and (c) the flexibility to use resources at the school level was limited by the budget law. In response, the government designed in 2006 a new formula to allocate funds to schools and decided to allocate in pilot rayons the full.package of wage and nonwage resources to schools them authority to break down allocated budget by individual line items and to hire non-teaching staff on a contract basis. However, the overall general education budget of the rayons was still formed on an input-based principle.

70. In December 2006, based on the results of the five pilots, the government adopted a resolution to expand per capita funding to seven new rayons. Resources allocated in the pilot rayons will be based on a new per capita formula, while non-pilot rayons will continue to receive funds based on the old norms. Since the great majority of school budgets consist of wages, differences in allocation formulas may not be significant for the small pilot being implemented. The resolution specifies that both budget distribution and general education budget formation will be undertaken in schools in the pilot rayons on a per capita basis as of 2007. This will ensure that pilot schools that have begun to capture efficiency gains by reducing number of classes will not be allocated a reduced budget as a result.

71. The Ministry of Education developed in the summer 2006 a system to monitor implementation of per capita financing, including Jinancial management, with assistance of USAID and support from the World Bank. It introduced the system at the central level and in the five rayons piloting per capita financing. Its introduction in the seven new rayons will be supported by the grant from the Fast Track Initiative. This grant has also supported adaptation to Tajikistan conditions of the training module developed under a USAID-supported project for rayon and school financiers and bookkeepers. In addition, the grant has supported the actual training in the seven new rayons.

72. Other reforms of the education sector envisaged to be supported through the PDPG 2 operations are progressing, but more slowly than expected. A recently commissioned study will recommend reforms of the wage and promotion system to improve incentives for education workers. The 2007 budget includes wage increases for education workers averaging 15 percent

21 effective April 1, 2007. All supplements-except class leadership and textbook correction-have been integrated into base pay starting in April 2007. This is the first step in designing and adopting a new remuneration and promotion system that compensates education workers based on level of responsibility and qualifications. As an integral element ofthe wage reform in the education sector, the government is committed to improve the stavka system to ensure efficient use of human and financial resources. A study (funded out ofthe Education Modernization Project) that will analyze the current situation and recommend reforms ofboth the wage and stavka system is expected to be completed in July 2007. The Government plans to conduct in 2007 a school census for the whole country in the context of the education management information system, with financial assistance from the Fast Track Initiative grant, the Asian Development Bank, and German Technical Cooperation. This census will serve as a data and analytical base for a rationalization plan for school infrastructure for further roll out of per capita financing and implementation ofthe education management information system.

Table 3: Agreed changes in PDPG 2 prior actions and milestones

Pillar 1: Promoting private sector development Improving- the investment climate (i)Business Licensing Licensing licensing, permits, and 1. Adopt the necessary measures 1. Submit to the parliament draft Number 1 inspections. to ensure the implementation of the amendments to existing legislation to dropped, amended licensing law, including: ensure compliance with the amended because this is (a) public awareness campaign law on licensing. not a policy (including publication and public 2. Adopt amended regulations to action. no dissemination through mass media), ensure consistency with the amended change in the and (b) training of public officials law on licensing. other two prior on the new requirements under the actions. law (including training program by Civil Service Department). 2. Submit to parliament amendments to all laws to ensure compliance with the law on licensing. 3. Government ofTajikistan to adopt amendments to secondary legislation on licensing. Inspections Inspections

1. Issue new by-law and regulations 1. Adopt government and No change. (at inspecting agency level) for the presidential decrees to implement the The indicators new law on inspections. new law on inspections. are now more 2. Submit to parliament 2. Submit to the parliament draft clearly amendments to all laws to ensure amendments to other laws covering specified. compliance with the new law on inspections to ensure compliance with inspection. new law on inspections. 3. Government ofTajikistan to 3. Issue new regulations (at inspecting adopt amendments to secondary agency level), and manuals and at least legislation on inspections. one checklist for at least 2 agencies for the new law on inspections. Transparency Transparency Transparency and account- ability in 1. Disclose detailed information on 1. Disclose information on all 2005 No change. privatization all asset sales in 2005. and 2006 asset sales by the state and enhancing 2. Implement the communication committee on investments and state competition strategy. property management in the media.

22 Reform Proposed PDPG 2 Prior Action Amendments to the Comm en ts Areas PDPG 2 Prior actions 2 Adopt an action plan to implement the comunication strategy, and

I implement short-term measures. tCompliance Review Compliance Revzew 1. Complete and make publicly 1. State Committee for Investment and No change. available the results of a compliance State Property management submits all review of randomly sampled information requested by the privatization transactions in 2005. international firm carrying out the 2005 2. Adopt and implement remedial and 2006 random compliance review. measures to address the deficiencies 2. Adopt measures to address identified by the 2004 compliance deficiencies identified by 2004 review. com~liancereview Laws on Competition and Natural Monopolies: Monopolies: 1. Revise implementing regulations 1. Revise implementing regulations No change. to ensure compliance with the (government decree and Anti-monopoly amended competition law. Agency internal regulations when appropriate) and institutional mechanisms to implement new 2. Submit to parliament competition law. amendments to the law on natural 2. Submit to parliament new draft law monopolies. on natural monopolies acceptable to IDA. 1 Regulatory reform in key strategic sectors

1. By the end of December 2006, 1. Adopt presidential decree No change in issue and implement government acceptable to IDA on separation of prior action. decree on separation of policy policy-making and technical making and technical regulation regulation. Development activities in civil aviation acceptable 2. Adopt a government resolution on of business to IDA. restructuring Tajik State Airlines, which plans is 2. Develop a business strategy (with foresees by the end of2008 separation of deferred to timetable) ofthe Tajikistan State airlines, airports, and air traffic control. PDPG 3, Airline Company. because these 3. Adopt government decree on require more separation of airlines, airport, and air time than traffic control, with a time-bound originally action plan and demonstrate progress expected. in implementation satisfactory to IDA. 1. Amend the existing technical 1. Publish revised cotton pricing Prior action regulations to ensure compatibility method (methodica) to be used in changed, with new international cotton place of all previous versions. because grading standards and cotton 2. Accredit a joint venture to provide technical pricing method satisfactory to IDA. cotton grading services, (subject to the regulations will 2. Publish widely the revised cotton laboratory being established under Asian take longer to pricing method. Development Bank financing). amend than 3. Accredit at least one previously internationally recognized cotton expected. This grading company to provide universal condition is cotton grading services. now deferred until 2008. Continue implementing the Energy 1. Complete separation of functions No change. Sector Development Strategy, between Barki Tajik and Ministry of especially: Energy (per presidential decree). 1. Adopt government decree on the 2. Issue government resolution raising separation of policy making and electricity tariffs (up to full cost recovery commercial operations, by December level) in line with the agreed schedule 3 1,2006. (2007-2010), and an instruction of the

23 Reform Proposed PDPG 2 Prior Action Amendments to the Comments Areas PDPG 2 Prior actions 2. Adopt government decree on government adjusting gas tariffs in line energy the tariff adjustments (up to with increases in import pnces. full cost recovery level) in line with the agreed schedule (2007-2010)

Reforming public sector manapement Public sector 1. Implement first set of short- No change. reform term measures as specified in Milestones are strategy strategy matrix. now specified 2. Launch the implementation of the in detail under second set of priority measures in the each subsector. strategy matrix, as announced on an annual basis. (a) Ration- 1. Complete the horizontal 1. Complete the horizontal functional The prior alization of functional review and submit review ofthe central level of the action has core public proposals and recommendations for executive. changed. The adminis- consideration by the government, 2. To implement the Public elections have tration including on: (a) the allocation of Administration Reform Strategy (March led to new structures responsibilities for budget preparation 15,2006), establish a working group proposals for and execution, (b) assignment to one through a presidential decree to develop government institution of the responsibility for the concept for the structure of the restructuring, private sector development policy public administration and measures for which has issues, and (c) rationalize structures its realization. Within two months of its delayed the for investment planning. establishment, the working group shall adoption of a 2. Adopt a new structure of central develop and submit for approval of the new structure. ministries and agencies and a time- Executive Office of the President a time- A trigger in this bound restructuring plan for based action plan that includes the stages area will be implementation of the results of the of(a) analysis ofthe current situation, included in review. (b) development ofproposals for the PDPG 3. structure of public administration as well as reporting and accountability arrangements, (c) public awareness measures, and (d) development ofa concept and measures for its realization. (b) Civil Wage reform Wage reform service reform 1. Adopt government decree on 1. Adopt government No change. the implementation of the second decree/resolution on the phase in wage decompression as implementation of the second phase in agreed with IDA. wage decompression as agreed with IDA. Civil service management Civil service management A policy reform has 1. Adopt secondary legislation to 1. Adopt new civil service law/. been added, implement new job classification and 2. Adopt a government resolution and because of wage grid in all government secondary legislation on merit-based government’s institutions; and recruitment and promotion. decision to 2. Adopt secondary legislation on draft a new merit-based recruitment and civil service promotion. law. Introduce a computerized civil service register Adoption of the new job classification system and wage grid is deferred to PDPG 3.

24 1 (c)Public Medium-term e.xpenditure framework Medium-term expenditure framework MTEF to be implemented in 1. Implement the medium-term 1. Issue medium-term expenditure stages, starting budget framework action plan. framework instructions. with a pilot 2. Government to approve a budget 2. Issue budget instructions for the sector. strategy paper for the 2008-1 0 that pilot sector in accordance with the To avoid contains sector policy priorities and instructions for the medium-term overtaxing resource ceilings for the sectors. expenditure framework (as part of the capacity ofthe 3. Improve the quality ofbudget budget guidelines). Ministry of monitoring reports. Finance, 4. Disseminate the results of the preparation of public expenditure tracking studies the budget and take action to improve resource strategy paper flow in health education. isdeferred. A more manageable budget monitoring report is being completed, but this has been dropped from matrix because it is not a policy action. Procurement reform Procurement reform

1. Amend by-laws in accordance 1. Adopt government resolution ‘‘ on Procurement with the new procurement law. approval ofthe draft law ofthe Republic reforms now ofTajikistan ‘on the repeal of the law on more clearly bidding.’ ” specified. 2. Adopt standard bidding documents for goods, works, and services, and adopt implementing regulations as referred to in the public procurement law, acceptable to IDA.

Internal control Internal control

Adopt a strategy for the development Adopt a government resolution The milestones of a public sector internal audit endorsing the strategy for the have been function satisfactory to IDA. The development of a public internal changed to strategy should include (a) staffing financial control. reflect changes and skill requirements, (b) audit in approach and methodology, and (c) government’s structural and institutional plans following arrangements. the Nov. 2006 election. External audit External audit

1. Develop amendments satisfactory Issue a letter from the president The milestones to IDA to update the law on state declaring commitment to develop an have been financial control. independent audit function in Tajikistan changed to 2. Develop and adopt an action plan and announcing the formation of a task reflect changes for building capacity ofthe State force that will be responsible for setting in government Financial Control Committee out the options. institutions and satisfactory to IDA and implement plans following key recommendations outlined in the the action plan. reorganization after the Nov. 2006 election.

25 Public service elivery (a) Primary 1. Adopt a government decree 1. Adopt a government resolution Milestone 3 has health care that expands the primary health that allocates in 2007 a greater share been dropped, care share of wage increases in of wage increases in health sector to because this health in 2007 as agreed with IDA. primary health care workers, as issue will be 2. Adopt government decree on agreed with IDA. taken up reintroducing the fully-funded basic 2. Introduce through a government through the benefits package in one oblast in 2007 decree a calculation of co-payment health sector on a pilot basis and integrate the basic categories and pricing for a guaranteed project. benefits package into the hospital basic benefit package acceptable to IDA. budgets for that oblast. 3. Adopt a government decree specifying the formula for per capita financing in health by March 2007. (b) Education Adopt interministerial instruction or 1. Through a presidential decree, More under- order (by Ministry ofFinance and Integrate all allowances and bonuses into standing of Ministry of Education) to: base pay, except for no more than two weaknesses in additional allowances or bonuses, as an the stavka 1. Design and adopt a new stavka initial step in designing and adopting a system needed system that ensures that teacher loads new remuneration and promotion system before are as close as possible to full time that compensates education workers consensus on equivalent. based on level ofresponsibility and reforms can be 2. Design and adopt a new qualifications. reached. remuneration and promotion system 2. Expand implementation ofper Reforms that compensates education workers capita financing through a government deferred until based on level of responsibility, resolution to additional rayons. after deeper qualifications, and performance. analysis has 3. Adopt regulations on been accountability and financial completed. management at school level.

26 4. PROPOSED OPERATION

A. Descriptionof the Operation

73. Programmatic Approach. This is the second of the three programmatic development policy operations consistent with the Country Partnership Strategy finalized in July 2005. The full details of the policy actions for the first two operations as well as the tentative policy actions for PDPG 3 are specified in the government’s Letter of Development Policy (annex 1) and the policy matrix (annex 2). The policy actions for PDPG 3 are as yet preliminary and will be more firmly articulated as preparation of the follow-on program proceeds, reflecting the findings and recommendations of analytical work, developments in the policy dialogue, and changing country circumstances.

B. Objectives, Themes, and Policy Areas

74. Development objectives. The development objectives of the proposed PDPG are to improve the environment for private sector development, and to improve overall functioning ofthe public sector and the delivery of key public services. The proposed program is aligned with the first two pillars ofTajikistan’s PRSP.

75. Themes of the operation. To achieve both objectives, the program requires maintenance of macroeconomic stability. To promote private sector development, the program will support measures to reduce the cost of doing business, promote transparency of the privatization process, and assist with regulatory and institutional reforms in key strategic sectors (aviation, cotton, and energy). To improve the overall functioning ofthe public sector and improvements in the delivery ofpublic services, the program will support public sector reforms aimed at improving public sector management, and the efficiency and effectiveness of public spending. The program will also support reforms in education and health sector policies to improve access, quality, and equity of services. The table below lists the prior actions agreed with the government for PDPG 2 and triggers for PDPG 3.

27 Area PDPG 2 Prior Actions PDPG 3 Triggers

Key license-granting ministries and agencies issue internal instructions to ensure that their administrative procedures comply with the law and regulations on licensing. Issue inspection manuals and checklists for all key types of inspections and all agencies specified in the new law on inspections. inspections. Aviation Adopt presidential decree acceptable to Implement the restructuring in accordance IDA on separation ofpolicy-making and with the timetable set forth in the technical regulation government resolution for the separation of airport, airline, and air traffic control. Cotton Publish revised cotton pricing method (methodica) to be used in place of all previous versions. IC SERVICE DELIVERY Adopt government resolution endorsing the draft concept (which is acceptable to IDA) for the structure ofthe public administration and measures for its realization. Civil service reform * Adopt government decreeiresolution on Implement the third phase in wage the implementation of the second phase decompression as agreed with IDA. in wage decompression as agreed with IDA. rExternal Audit Issue a letter from the president Develop a strategy and action plan for the declaring commitment to develop an establishment of an independent external independent audit function in Tajikistan audit body and draft the legislation which and announcing the formation of a task shall govern the external audit function. force that will be responsible for setting out the options. Improved public Health Adopt a government resolution that service delivery: Adopt a government resolution that allocates in 2008 a greater share of wage r allocates in 2007 a greater share of wage increases in health sector to primary increases in health sector to primary health care workers, as agreed with IDA. I------health care workers, as agreed with IDA. C. Linkages to Country Partnership Strategy

76. The proposed three Programmatic Development Policy operations support the key policy reforms intended to meet the objectives of the Country Partnership Strategy for fiscal 200609. The Country Partnership Strategy, discussed by the Board on July 26,2005, focuses on maintaining growth in the short term and building a foundation for growth in the future. Developed in close consultation with the government, it focuses on three strategic objectives: (a) improve business opportunities in rural and urban areas, (b) enhance the quality of health and education, (c) improve the delivery ofenergy services and exploit the country’s hydropower potential. Due to limited IDA resources and taking into consideration the Bank’s comparative advantages, the Bank’s assistance to Tajikistan will be highly selective.

77. To achieve the objectives of the Country Partnership Strategy, the proposed operation will support a selective cross-cutting reform program. To improve business opportunities in rural

28 and urban areas, the operation will support reforms aimed at streamlining licensing and inspection regimes, ensuring greater transparency of the privatization process, promoting market competition, and improving transport. The operation will contribute to enhancing quality of education and health services by supporting the reform ofthe budget allocation mechanism (per capita allocation), and the other reforms planned for these sectors. The operation will also support energy sector reforms aimed at improving the delivery of energy services and increasing the supply ofelectricity exports. These reforms will complement the Bank’s ongoing and planned investment projects in public administration, education, health, agriculture, and energy. The policy matrix presented in annex 2 shows how each of the proposed reform programs is linked to the objectives ofthe Country Partnership Strategy.

D. Collaboration with the IMF and Other Donors

78. The Programmatic Development Policy Grant and the IMF’s support complement each other. The Bank takes the lead and provides background to the IMF program in private sector development and privatization, enterprise reforms, farm productivity, and regulatory reforms (see details in annex 4). The Bank and the Fund share responsibility in public sector management, budget planning and execution, financial sector reforms, and utilities’ reform. The Fund and the Bank cooperate on fiscal policies and reduction of quasi-fiscal deficits, which requires close cooperation with the Bank’s programs for health, education, and infrastructure. The Fund also leads in tax reform, and in revenue and expenditure management. In these areas the Bank takes into account the Fund policy recommendations and ensures consistency between them and its own measures. In addition, there is close coordination between the Bank and the Fund concerning the public sector reform agenda.

79. The Bank is coordinating closely with other development partners in Tajikistan. The development partners have recently established a donor coordination council, with a rotating chair (currently held by the Swiss). The members of the council, which meets monthly, discuss developments in Tajilustan, exchange experience, and share information on current and planned interventions. The establishment of this forum has greatly improved coordination of development partner support in the country.

80. The proposed operation complements the support of development partners in many areas. For example, the Bank is supporting the development of a new competition policy and communications strategy, which the European Commission will help to implement. The Asian Development Bank will support the implementation ofthe new cotton grading system. The Bank is supporting the development of policies to improve the management of the transportation system; the Asian Development Bank, the Islamic Development Bank, the Kuwaiti and Saudi Funds will support the construction of infrastructure. In addition, the proposed operation introduces policy measures that would improve access to Tajikistan, while the EBRD (with restructured programs based on discussions with the Bank) will finance and support their implementation. The Bank, the EC, DFID, and USAID are working closely to support the government’s reform program in the areas ofpublic financial management. The Bank, USAID, Asian Development Bank, and Sweden are all supporting reforms ofthe health sector. All development partners supporting the education sector have endorsed the government’s national strategy for education development and are aligning their support behind it. DFID and Japan are assisting with developing restructuring plans for specific government entities in close coordination with the Public Sector Reform Project. The EC, through its Civil Service Reform Project, is assisting with the development of a strategy for civil service reform and a job description system for civil servants. For details see annex 3.

29 81. Stronger partnerships with non-OECD donors are planned. The Chinese have become important financiers in Tajihstan. They are keen to avoid duplication and waste in their operations and are interested in strengthening their collaboration with other development partners in areas of common concern. For example, the Bank and the IMF are discussing issues of long-term debt sustainability with their Chinese counterparts. The Bank and other development partners will discuss specific areas of mutual interest, such as infrastructure development and regional integration.

E. Relationship with Other Bank Operations

82. The proposed reforms are based on extensive Bank analytic and advisory activities carried out during the past two years. A public expenditure and institutional review, a country procurement assessment report, a country financial accountability assessment, a public and civil service wage note, and a remittances note have informed the public sector reform program. A trade diagnostic, an investment climate assessment, an aviation sector note, an energy utility reform review, the Central Asia regional electricity export potential study, and an agricultural development strategy have highlighted key reforms required to attract private sector investment. A poverty assessment update has deepened understanding of poverty and its dynamics, and is important for the design of policy reforms that effectively reduce poverty. A programmatic public expenditure review is supporting Tajihstan’s first public expenditure and financial accountability (PEFA) review, and analyzing the country’s prospects for achieving the MDGs and long-term growth, and providing support for the introduction ofthe MTEF. Two public expenditure trackmg surveys, one for health and one for education, will promote transparency and efficiency of expenditure in these sectors. Annex 3 shows the linkage between Bank’s analytical and advisory work and the reform actions ofthe proposed operation.

83. The proposed operation supports policy reforms that are critical to the success of ongoing and planned investment and technical assistance operations. The proposed operation will support adoption of policies critical for reform of the public administration; capacity to implement the reforms will be the focus of a Bank-financed Public Sector Reform Technical Assistance Project. Similarly, the program supports policy reforms in the public financial management, education, health, agriculture, and energy sectors-all areas ofrecent or forthcoming Bank-supported projects. Reforms to improve the investment climate and to redefine the role of the state in the economy will complement support of the IFC and MIGA to promote private sector development. Annex 3 shows the links between PDPG policy actions and other investment operations.

F. Lessons Learned

84. The design of the proposed operation reflects several lessons from implementation of the previous CAS in Tajikistan, other operations in Tajikistan, and policy-based loans in other countries. These include:

0 Government ownership of the reform program is essential for success. Extensive experience demonstrates that government ownership of the reform program is the single most important criterion for success. The medium-term reform program of the proposed series of programmatic operation has been designed in close collaboration with key relevant ministries and the executive office of the presidential administration. The government has consistently demonstrated its commitment to the reform agenda by continuing to implement the agreed reforms.

30 0 Focus on a limited set of key reforms. The proposed Grant supports deep reforms in a few selected areas. The program includes only the critical actions that the government believes that it can realistically implement in a three-year timeframe, backed by sector-specific projects, capacity-building, and communication campaigns. These are the reforms that the government is already committed to and has been carrying out. The proposed operation contains ten core prior actions (see table 4) that are critical to the achievement of development objectives ofthe Grant.

0 Build capacity for implementation of the reform agenda. Passage of legislation and adoption of strategies have often had little impact in Tajikistan, because of lack of institutional capacity to implement reforms. The Public Sector Reform Project is helping to build capacity ofthe public administration to implement reforms.

0 Build effective partnerships with the IMF and other donors in designing the proposed Grant. Substantial progress is being made with donor coordination, with the Bank regularly consulting with other development partners on a wide variety ofissues. This has led to a greater division of labor among partners and reduced duplication and waste. The IMF, the Asian Development Bank, the EC, and the major bilateral donors in Tajikistan are all informed ofthe status ofthe implementation ofthe prior actions of the PDPG operations to ensure that all are able to advance the reform agenda.

0 Offer a series of annual single tranche budget support operations, rather than multi- tranche operations. Single-tranche operations, which are approved only after the government has implemented agreed reforms, require both the government and the Bank to be realistic about what is possible, and then to agree on a program ofcompleted actions that is acceptable to both sides. The proposed program is a single tranche operation-the second of a proposed series ofthree annual operations-each ofwhich furthers the reforms supported by the previous operation. This approach allows the government and the Bank to adapt the medium-term program as new information becomes available and feasible options for realizing the intended development goals change. It also ensures that the flow of funds is predictable and that the technical assistance required to implement and sustain reforms is available.

31 Box 2: Good practice principles on conditionality Principle 1: Reinforce ownership The proposed operation is based on the Tajikistan National Development Strategy and the PRSP. It also responds to several government sector strategies, including the national strategy for education development, the public administration reform strategy, an investment climate assessment, an aviation sector note, an energy utility reform review, and an agricultural development strategy. All ministries and agencies undertaking policy reforms presented in the matrix have participated in periodic workshops to discuss and agree on the objectives ofreforms, current status, and next steps.

Principle 2: Agree up front with the government and other financial partners on a coordinated accountability framework The PDPG program is summarized in an agreed policy matrix in annex 2. The matrix contains both policy actions and indicators ofexpected outcomes. The State Advisor for Economic Policy in the Executive Office of the President is responsible for monitoring progress with the agreed reform program and for coordinating the actions of the other agencies and ministries involved. The Bank consults regularly with other development partners in Tajikistan to ensure that aid is as effective as possible.

Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances The accountability framework is based on recent Bank analytical work, including a study of macroeconomic management, a public expenditure and institutional review, a country procurement assessment report, and a country financial accountability assessment. Two public expenditure traclung surveys, one for health and one for education, and several poverty and social impact studies are also contributing to the accountability framework.

Principle 4: Choose only actions critical for achieving results as conditions for disbursement The proposed PDPG 2 operation contains only ten core prior actions and 22 benchmarks. All are part ofthe agreed framework set out in the policy matrix.

Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support Progress reviews of the policy actions in specific areasand of the operation as a whole are held regularly with government officials from ministries and agencies participating in the project. These reviews allow the Bank to update the matrix on the basis of actual and expected performance and to communicate to the government what is essential to enable the approval of the operation. Predictability is further strengthened through the use of a policy matrix containing agreed reforms of a series of three annual operations-each of which furthers the reforms supported by the previous operation.

5. OPERATION IMPLEMENTATION

A. Poverty and Social Impact

85. Poverty and social impact of this operation is likely to be positive. In the short term, the proposed reforms in health and education are likely to result in improved access and quality of services to the poor. Similarly the impact of the revised energy tariffs will include special provisions to avoid negative impacts on the poor with a subsidized rate for the vulnerable groups. n

32 addition, reforms in the aviation sector will improve access and reduce cost of transport for migrants, many of whom earn low incomes. In the medium term, reforms proposed in public administration reform strategy should yield benefits through more efficient and effective public sector management. The planned reforms do not envisage further retrenchment ofpersonnel in the short-term; however, if implementation ofthe medium-term measures were to result in the need for downsizing in the public service, a poverty and social impact analysis would be undertaken to facilitate the adoption ofmitigation measures for civil servants to be made redundant.

86. Poverty and social impact analyses have recently been carried out to ensure that the government and the development partners understand the potential impact of policy reforms on spec@ groups. The studies include an assessment of the potential impact of changes in energy tariff policy, and a study investigating the impact ofchanges in policies affecting the cotton sector. These studies have informed the design of the reform program in several ways. For example, the study of energy tariff policy, completed in April 2005, recommended that the government adopt a three-band tariff structure that will allow the poor to pay subsidized rates for energy, while ensuring full-cost recovery for the energy sector through imposition ofhigher tariffs on the better off.l3 The government has now designed a new tariff structure consistent with this letter of development strategy for the energy sector that will be implemented gradually starting in 2007 and is expected to be completed in 2010.

87. A poverty and social impact analysis for the cotton sector, completed in June 2004, estimated that cotton yields would increase from the current 1.9 tons per hectare to 2.8 tons per hectare, if all the necessary reforms were carried out. This would translate to almost US$lOO million in additional revenue from cotton sales. The study proposed focusing in the medium term on reforming contracting, pricing, and standards, which would benefit local farmers and farm ~0rkers.l~This study also notes that such reforms will be easier to implement than resolving farm debt or pursuing land reform.

88. Additionalplannedpoverty and social impact analyses include:

0 Impact ofadopting a new cotton pricing scheme and international cotton grading standards on rural welfare. 0 Impact ofthe proposed introduction ofhigher energy tariff, for 2007-10 on employment opportunities and income level ofaluminum workers. 0 Impact ofthe introduction ofthe basic benefits package for primary health care on the poor.

89. In general, reforms supported by the proposed operation are expected to stimulate economic growth and reduce poverty. For example, cotton farmers are expected to benefit from the improvements introduced under the proposed program. Resource allocation within the energy sector and across the economy is expected to improve through cost recovery tariff reform. The private sector will benefit from the aviation sector reforms as they will reduce the cost of transportation, stimulate investment and improve profitability of enterprises. In addition, the reforms are expected to improve consumers’ welfare and promote the free movement of labor. The poor will be assured of access to affordable and quality primary health care through the

World Bank. “Provision of Energy Services to the Poor: Design of Sustainable Social Protection Schemes under Energy Sector Reforms.” April 2005, Washington D.C. ’‘ World Bank. “Tajikistan: Poverty and Social Impact Analysis ofCotton Farmland Privatization.” ESSD and PREM, June 2005, Washington D.C.

33 implementation of the basic benefits package. Similarly, the population will have better quality education through reform ofthe per capita allocation.

90. Improved governance is important to reduce poverty and access of public services by the poor. Improved management and incentive systems in the state administration aim to reduce the capture of policy processes by special interests. This is achieved by gradually improving civil servants’ earnings and the development of improved internal accountability mechanisms in the administration. It thus creates the conditions for the policy process to become more transparent and accessible, which will benefit those who have limited access to decision-making processes.

91. Consultations and outreach are being conducted on the proposed operation to ensure that it reflects the views of a broad range of stakeholders. Discussions are held regularly in Dushanbe with government officials across ministries and agencies, the private sector, nongovernmental organizations, and other development partners on the overall reform program. These have been critical in adjusting the program to reflect changing conditions and thinking in Tajihstan. Workshops have also been held with stakeholders on specific aspects of the reform program, including on proposed reforms of the licensing, inspection, and permits regime; cotton pricing and grading; energy tariffs; the privatization process; and the public sector. In addition, the government, with support of the Bank and other partners, is implementing a communications strategy to inform the public of changes in the licensing and inspection regimes and of past and planned privatization transactions. Measures have included broadcasting public service announcements on the reforms oflicensing, and publishing information on privatizations.

B. Implementation, Monitoring, and Evaluation

92. Amount and tranching. The proposed operation is the second of three programmatic single-tranche operations. The proposed operation would be provided in IDA grants in the amount equivalent to US$10 million. Funds would be disbursed in a single tranche upon effectiveness, expected in September 2007. Multilateral and bilateral donors are providing substantial technical assistance and policy advice in support ofthe government’s reformprogram.

93. Implementing agency. The Executive Office ofthe President is the implementing agency, and the State Advisor for Economic Policy will be responsible for overall implementation of the reform program, for reporting progress, and for coordinating actions among the other agencies and ministries involved. The department ofeconomic reforms and investments at the Executive Office ofthe President will be responsible for implementing the public sector reforms. The National Bank of Tajikistan (NBT) will monitor the macro stability measures. The Ministry of Economic Development and Trade, and the Ministry of Finance will be responsible for reforms of licensing, regulation, and the privatization process. The state committee on investment and management of public property will be responsible for implementing the privatization program. The line ministries involved (energy, education, health, agriculture, and transportation) are accountable for implementing the sectoral reforms specified in the reform program. The Borrower will open an account at the NBT against submission by the Borrower ofa simplified withdrawal application.

94. Monitoring and evaluation. Bank staff will continuously monitor implementation of the reforms specified in the program matrix of the proposed operation to ensure that progress towards outcomes is made during the three year program. The program document for the second and third operation will report on progress with implementation. Country capacity for monitoring will be strengthened through the ongoing Bank-supported Statistical Capacity Building Project. For instance, a living standards measurement survey is to be conducted in 2007-08 to be supported through this project, will help in assessing the impact of many of the proposed reforms on the

34 population as a whole and on different socioeconomic groups. DFID, the European Commission, and the Asian Development Bank are also providing support to strengthen capacity for statistics and monitoring and evaluation. An implementation completion report will be issued within six month following the closing date ofthe three-year PDPG program.

C. Fiduciary Aspects

95. Country Financial Accountability Assessment. The June 2004 CFAA concluded that the risk to public funds was high in Tajikistan, because of: (a) poor systems of public accountability and weak mechanisms for public sector transparency; (b) weak internal control systems and internal audit function; (c) weak institutional capacity to implement some ofthe budget reforms being undertaken; (d) fragmented budgets and poor cash management, (e) lack of transparency in state-owned enterprises; and (0 weak capacity with the legislative bodies to provide effective oversight over the working ofthe government.

96. Tajikistan has made substantial progress since then in various aspects of the public jinancial management. For example, the organic budget system has been thoroughly revised, the budget classification system has been changed, the treasury system has been modernized by introducing automation, a treasury single account has been established, quarterly budget execution reports are now routinely prepared, and external audits have become more timely. The government had also taken steps to strengthen the capacity ofkey accountability institutions in the country. For example, with a grant from the Bank’s Institutional Development Fund, the State Financial Control Committee (Tajikistan’s supreme audit institution until government restructuring in early 2007) had entered into a twinning arrangement with the U.K.’s National Audit Office to strengthen the skills of staff and to introduce modem auditing processes. In addition, through another grant of the Institutional Development Fund, Tajikistan has enacted a modem public procurement law. These efforts have resulted in Tajihstan achieving 8 ofthe required 16 HIPC indicators ofpublic financial management. This puts Tajilustan in the top quintile of HIPC countries as noted in the February 2006 IMF Staff Report and IMF assessment of public expenditure management under the Multilateral Debt Relief Initiative. However, the restructuring ofthe government that took place in following the elections ofNovember 2006 has undermined the independence of the supreme audit institution. The Bank and other development partners are now advising the Government on the importance of establishing a truly independent Supreme Audit Institute reporting directly to the parliament. The presidential administration has expressed interest in moving forward with this option.

97. Capacity to implement good policies also needs to be developed. The adoption of good policies is not enough to improve performance. Capacity is also needed. The government is worhng with the Bank in preparing the Public Financial Management Modernization Project, which, with the Public Sector Reform Project, are expected to strengthen capacity to implement improved systems of public financial management systems. A PEFA review, started in October 2006 and expected to be complete in March 2007, will provide a baseline for measuring progress with reforms of public financial management. A three year programmatic public expenditure review launched in 2006 by the Bank in close collaboration with key donors (European Commission and DFID) is assisting government in addressing institutional and capacity constraints related to introducing the MTEF and improving budget efficiency. A Report on Observance of Standards and Codes issued in January 2007 will help the government to reform the accounting and auditing legislation and practices in the country. Strengthening of the fiduciary aspects of the education sector under the Fast Track Initiative will help in improving systems in education and, ultimately, across the government. Fiduciary risk will need to be monitored closely on a continuous basis.

35 98. IMF safeguards assessment. The IMF’s most recent safeguards assessment, conducted in June 2003, noted several weaknesses at the NBT, including a qualified audit opinion by an international firm on the financial statements for fiscal 2002 that included audit observations with respect to guarantees issued and loans made to co‘mmercial banks, nonpublishing of annual financial statements, weak internal audit capacity at NBT, and infrequent and inaccurate periodic financial statements. It recommended several measures to address the weaknesses, mainly in the areas of financial accounting and reporting and auditing. The latest available IMF Article IV consultation report, completed in April 2005, concluded that the NBT was implementing the recommendations made in the safeguards assessment. The external internal audit of the NBT was completed for 2003, 2004, and 2005. However, details on progress made in implementing various recommendations, including results of audits for the latest three years, are not yet publicly available. Moreover, government abolished State Financial Control Committee under the reforms undertaken after presidential elections held in November 2006 and additional assurance measures are required in order to minimize the risks associated with current weaknesses of the PFM arrangements in the country. Accordingly, the team recommends opening a dedicated foreign currency deposit account at the NBT, in the name ofthe Ministry ofFinance, to receive funds under the proposed operation. The Government has agreed to utilize the foreign currency proceeds deposited into the foreign currency deposit account for foreign currency debt servicing (already included in the fiscal 2007 annual budget), thereby obviating the need to convert the foreign currency into local currency. Conversion ofthe foreign currency proceeds into local currency is not recommended, as government budget execution reports cannot be audited by independent auditor now that the State Financial Control Committee has been abolished. The Ministry of Finance will submit quarterly reports, providing details ofutilization ofthe proceeds ofthe grant, until proceeds have been fully utilized. The final statement on the utilization of the proceeds of the foreign currency and local currency deposit accounts will be subject to an audit under terms of reference acceptable to the Bank and by an audit firm acceptable to the Bank.

D. Disbursement and Auditing

99. Disbursement. The Borrower is the Republic ofTajihstan. The proceeds ofthe Grant will be disbursed upon effectiveness of the Development Financing Agreement. The Borrower will open and maintain a separate foreign currency deposit account in (US dollars) at the NBT, as part of the general foreign currency reserves of the government. The proceeds of the Grant will be deposited by the Association into such dedicated foreign currency deposit account. The IDA “negative list” restrictions, agreed during negotiations and specified in the Development Financing Agreement, will apply to the use of grant proceeds. If after depositing funds in the deposit accounts, the proceeds of the grant are used for ineligible purposes as defined in the Development Financing Agreement, the Bank will require the Borrower to either: (a) return that amount to the account for use for eligible purposes, or (b) refund the amount directly to the Bank.

100. Reporting and auditing arrangements. Through the Ministry of Finance, the Republic of Tajikistan will (a) report on a quarterly basis to IDA the amount received into the deposit accounts at the NBT, (b) provide confirmation ofthe amounts withdrawn andor transferred from the deposit accounts, including bank account numbers, date and names ofbeneficiaries, and (c) ensure that the proceeds of the Grant are not used for ineligible expenditures defined in the IDA “negative list” as agreed during negotiations and specified in the Development Financing Agreement. The deposit accounts and the transactions from this account to the ultimate beneficiaries’ accounts will be independently audited in accordance with terms ofreference to be agreed with IDA.

36 E. EnvironmentalAspects

101. The conclusion of an environmental screening of the proposed reforms, undertaken as per the requirements of OP 8.60, is that the reforms are not likely to be significant from an environmentalpoint of view. Details ofthe analysis for each reform area follow.

0 Maintaining macroeconomic stability. Macroeconomic stability is necessary for economic growth and poverty reduction, which may indirectly generate environmental benefits by encouraging the adoption ofmodern technologies which use resources more efficiently than those they replace.

0 Reforming licensing and inspections. Reform oflicensing in general will facilitate business entry and growth and reduce costs for businesses. This will result in uncertain environmental impacts, depending on the sectors that attract new investment, and the availability and cost-effectiveness ofnew technology. The reforms may be positive for the environment if they attract businesses into the formal sector, since formal businesses are more likely to comply with environmental policies. Reform of the inspection law will increase the accountability of inspectors and reduce the opportunity for rent seeking. This in turn will increase the effectiveness of the inspection process to detect violations in health, safety, environmental, tax, and other laws. In time, streamlining of specific environmental inspection and licensing rules will be necessary to ensure positive environmental outcomes from the reform process.

0 Improving transparency of the privatization process and market competition. Increasing the transparency and accountability of the privatization process will likely have a positive impact on the environment, because this transparency will include disclosure of a firm’s environmental liabilities for past contamination and current environmental performance. This, however, needs to be carefully monitored, as the country is expected to privatize some pollution-intensive industries in the near future. International best-practice suggests that addressing environmental issues upfront significantly eases the time and costs of privatization. Amending the competition and natural monopolies laws to increase competition among enterprises will have uncertain impacts on the environment. The cross- country evidence suggests that over time, competition leads to more efficient resource use, and thus reduces environmental impact of a unit of output. However, competition could also lead to negative environmental impacts if it encourages firms to use cheaper, but environmentally-damaging technologies. This again needs to be carefully monitored.

0 Aviation sector reform. The proposed operation seeks to improve efficiency and enhance competition in aviation. Although increased competition is expected to raise the number of flights between Tajikistan and other countries, this is expected to lead to adoption of more fuel-efficient, less noisy aircraft by the Tajik State Airline, with an overall benign impact on the environment. The operation does not support investment in airports, which is being supported by other development partners with oversight of the State Committee on Environment Protection and Forestry.

0 Cotton sector reform. The proposed operation aims to introduce a universal cotton grading system that will increase the confidence ofpotential end users of the quality of Tajikistan cotton being purchased. This will maximize the sales price and stimulate demand from end users for premium cotton. This will have only indirect, if any, impacts on the environment. An increase in demand for premium cotton could stimulate new production, or it could

37 encourage farmers to substitute higher-grade cotton for lower grade. An increase in cotton production with an efficient imgation and drainage infrastructure may prevent negative effects on the environment and soil fertility. However, it could also lead to land degradation, primarily through waterlogging, salinization, and erosion. It could further lead to (a) a potential increase in use or overuse of water; (b) an increase in use of chemical fertilizers, pesticides, herbicides and other chemicals; (c) an increase in operation of ginning factories and associated hazards; and (d) dumping of excavated sediments and other materials from irrigation and other drainage canals. The task team is aware of the risks and is coordinating actively with ongoing Bank projects, including the Rural Infrastructure Project, the Community Agriculture and Watershed Management Project, the Land Cadastre Project, and the Ferghana Valley Development Project to closely monitor and mitigate the potential environmental impacts arising from cotton production. The proposed Bank-supported Cotton Sector Recovery and Poverty Reduction Project and a project supported by the Asian Development Bank, will further strengthen capacity of the government to address environmental issues arising from reforms ofthe cotton sector. e Energy sector reform. Much of the forest loss in Tajikistan is due to lack of access to energy supply in remote rural areas. In the long term a more efficient energy sector is expected to reduce these pressures. The proposed operation will support separation of policymaking from commercial operations and restructuring of tariffs to promote cost recovery, while ensuring that the poor have access to a minimal level of service at affordable rates. These measures are expected to promote efficiency and conserve energy, which will have a positive impact on the environment. Without mitigating measures, reforming the tariff structure may have had a negative impact on the poor, according to the poverty and social impact analysis, which may have increased pressure on forests for fuelwood. However, this will be mitigated through provision of subsidies to low-income electricity consumers. The proposed operation does not support any investment operation for constructing new dams. Environmental impact assessments of future energy investments will be carried out under the projects that support them. e Reforming public sector management. The operation will support implementation of reforms of public sector management aimed at improving the efficiency and effectiveness of the public service and the delivery of health and education services. These reforms are not expected to have any impact on the environment. Efforts will be made in the future through these reforms to improve the efficiency and accountability of environmental agencies.

102. As a newly independent country emerging from a civil war, neither awareness of environmental issues nor institutional capacity to address them are well developed in Tajikistan. This is now changing. Tajikistan’s PRSP recognizes water pollution, soil degradation, water pollution, deforestation, and biodiversity conservation as environmental priorities and proposes a range of measures to address them. Tajikistan is an active party to several United Nations conventions and has prepared a National Strategy for Combating Desertification (2002), and a National Biodiversity Conservation Action Plan (2003). The country has also adopted environmental laws and regulations, including a requirement that environmental impact assessments are conducted for all new economic activities. The borrower also imposes fees and fines on all major polluters. The State Committee on Environment Protection and Forestry in January 2004, merging the Ministry for Environment Protection and the Committee on Forestry was recently merged with the Ministry ofApculture. This has raised some concerns that this may interfere with some ofthe core functions of the state committee (now a department). The task team would monitor developments in this area as things are stiIl evolving and continue its dialogue with

38 the government to focus its efforts in conducting further reforms in the environmental sector in short term and to strengthen the capacity ofenvironmental authorities.

103. Gaps in capacity is being strengthened through a number of Bank-supported projects. The Government is strengthening its the capacity to assess and mitigate environmental impacts of economic activities through training and hands-on experience. The Bank, through four ongoing rural development projects, is strengthening the local line departments by supporting the upgrading of their national and local level analytical laboratories and training their staff with internationally- recmited environmental and natural resource protection specialists. The Bank has also assisted the government in holding conferences and workshops on natural resource and environmental management and in disseminating their proceedings to the public. Additional measures to strengthen the government’s institutional capacity for environmental management will be addressed through the Bank’s country program and programs of other development partners. A country environmental analysis that examines the institutional framework and capacity of the country to address its environmental challenges will be undertaken during the next phase ofthe program.

104. Opportunities for mainstreaming environmental issues in government policies and programs, and additional measures to strengthen capacity for environmental management will be identified through a country environmental analysis. With support of a multidonor trust fund, the government will undertake a country environmental analysis in 2007. This is aimed at deepening the understanding of the country’s major environmental challenges, and assessing capacity within the country (both public and nongovernment) for sound environmental management. The findings of the analysis are expected to guide support of the Bank and other development partners to strengthen capacity in Tajikistan for sound environmental management.

F. Risks and Risk Mitigation

105. Successful implementation of the medium-term reform program faces risks, for which mitigation measures have been identified. Specific risks .include:

0 Weak implementation capacity inhibits implementation and coordination. Capacity in Tajilustan to implement a complex reform program is weak. Development partners are helping to strengthen capacity in several ways. A Japanese Policy and Human Resources Development Grant is helping to build capacity through support for design and sequencing of reforms, analytical work, and intergovernmental coordination. The Bank will help to strengthen capacity of central government operations through the Public Sector Reform Technical Assistance Project. It will strengthen capacity of the sector ministries and government agencies involved in the program through ongoing and planned projects. Other development partners are working with the Bank to ensure that capacity building initiatives are well coordinated and meet the needs ofthe government.

0 Poor governance and corruption prevents effective use of resources and discourages private sector investment. Tajikistan’s public financial management system is characterized by poor internal controls, lack of transparency, high level of corruption, low capacity, poor cash management and budget execution, all of which undermine efforts to enforce fiscal discipline. During implementation, fiduciary risks will be mitigated by: (a) creating a dedicated foreign currency account into which Bank funds will be disbursed; (b) regular reporting on the use of funds disbursed; and (c) requiring an independent audit on the use of funds provided under the proposed operation. In addition, the following actions will be required in order to realize longer term progress in public financial management: (a) commitment by the authorities to implement key recommendations of the CFAA, the

39 Country Procurement Assessment Report and other IMF reports; (b) satisfactory implementation of the grants from the Bank’s Institutional Development Fund supporting public sector reform program of the government; (c) satisfactory implementation of the Public Sector Reform Project, and the proposed Public Financial Management Modernization Project, currently under preparation. Progress in strengthening the public financial management will be assessed through the IMF fiscal transparency Reports on Observance of Standards and Codes (completed in January 2007), and a fiduciary update to be conducted by the Bank in fiscal 2008. A PEFA to be completed by March 2007 will provide baseline data against which to benchmark Tajilustan against other countries and to measure progress in the area ofpublic financial management. The fiduciary assessment of the education sector being undertaken under the Fast Track Initiative is another important step in improving the management ofexternal and public funds. It has resulted in an action plan aiming at strengthening the procurement and management capacity of the Ministry of Education. The Bank will support opportunities for candid dialogue between the government and other stakeholders on the issues, and will support civil society’s efforts to be able to better track and monitor the use of government funds. The Bank sees closer collaboration with donor partners as key to moving this agenda forward. e The government contracts excessive non-concessional loans, which it cannot repay. The government has already contracted a US$604 million loan with the Chinese. This loan is concessional and is being used to construct roads and electricity transmission lines, it also raises risks of future debt distress should the economy grow more slowly than expected or should the projects prove to generate fewer benefits than projected. Additional loans, especially those provided on commercial terms will add to the risk ofdebt unsustainability. To mitigate this risk, the Bank in collaboration with the IMF is maintaining an active dialogue on the issue. Should the country be found to be in violation of the Bank’s non- concessional loan policy in the future, the grant element of IDA credits will be reduced. A severe violation could lead to a cut in Tajilustan’s overall IDA allocation. e A complex political economy prevents positive reform, Tajikistan has been independent from the former Soviet Union for slightly over ten years and is still recovering from a devastating civil war. Its institutions are very weak and vulnerable to capture by special interests. Stakeholders who benefit from the current institutional arrangements are likely to resist reforms that will leave them worse off. The president’s overwhelming majority in the November 2006 polls, however, strengthens his mandate to implement the reform program. Nonetheless the Bank will continue to support reforms by improving and expanding its efforts at communications, emphasizing the costs of continuing with the economic status quo, the long-term benefits of reforms, and opportunities for accelerating growth through greater private sector involvement in infrastructure. Better dissemination ofthe findings of Bank-supported analytical work will be an important vehicle of this enhanced communications effort, but it will also involve proactive efforts, with assistance from the external affairs units in the country office and in headquarters. The Bank will regularly monitor progress and actively engage in dialogue to help government and with the opposition. It will continue to coordinate closely with other development partners to monitor and respond to political developments. e External factors present unknown risk. Tajikistan is exceptionally vulnerable to shifts in the external environment, due to its small internal market, its landlocked position, and its dependency on a small number of commodity exports, limited number of transport routes, and workers’ remittances for income and for foreign exchange. Deteriorating terms of

40 trade would negatively affect rural incomes and Tajihstan’s balance of trade. Political or economic instability in neighboring countries also poses a significant risk to Tajilustan; as such instability could lead to closures of borders or trade disruption. A slowdown in the Russian economy or tightening the implementation of a new Russian immigration law could result in a decline in remittances. Apart from pursuing suitable economic policies to diversify its exports, as an active member of the Central Asia Regional Economic Cooperation, Tajikistan is addressing some ofthese trade and transportation issues through regional cooperation efforts. It is maintaining a close dialogue with Russia to ensure that Tajik workers are able to continue having visa-free access to Russia’s labor markets.

41 Annex 1: Letter of Development Policy

Unofficial translation

THE PRESIDENT OF THE PREPUBLIC OF TAJIKISTAN

Dushanbe NO.12.211-10 26 April 2007

H.E. Mr. Paul WOLFOWITZ President The World Bank 1818 H Street, N.W. Washington, DC 20433

Mr. President,

Please allow me to express my gratitude to you and the World Bank for the support that is being provided to the government reform program in the Republic ofTajikistan.

The objective of this Letter of Development Policy (LDP) is to outline recent developments in Tajikistan’s economic and social situation and the related prospects over the next three years. It is based on National Development Strategy (NDS) for the period to 2015 and the Poverty Reduction Strategy (PRS) for 2007-2009, which implementation has been started by Government. The NDS reflects the country’s vision of it strategic development, while PRS presents a medium-term program as implementation tool of NDS objectives in the medium-term. The LDP is also based on the sector strategies, for example, the Public Administration Reform Strategy (PARS), and the National Strategy for Education Development (NSED), which are being implemented with support of the donor community.

In the framework ofthe World Bank’s Country Partnership Strategy (CPS) for Tajikistan covering FY 2006-2009, the Government has been working closely with the World Bank in implementing reforms in the context of a Programmatic Developing Policy Financing (PDPF). PDPF aimed at promoting growth, reform public sector and improve the quality of public services delivery. We are committed to the reform agenda agreed under the PDPF as evidenced by successful implementation of the agreed reform policy actions in the first year.

With respect to the government’s economic program, we would like to highlight some of the results achieved in recent years. According to experts, Tajikistan has been one ofthe fast-growing economies in ECA with an average five year growth rate of 9 percent (2001-05). This high growth rate reflects the progress achieved during initial stage of structural adjustment reforms, balanced macroeconomic policy, as well as economic rebound after the civil war, favorable external factors, and strong inflows ofremittances.

42 This growth achieved in recent years has supported to the poverty reduction in the country. Thus the poverty rate (using a PPP ofUS$2.15 per capita per day) significantly fell by 25 percentage points (from 82 percent in 1999 to 57 percent in 2004). With that, in 2006 growth impairment was observed with 7 percent reflecting decline in trade due to increase of world prices for energy and decrease of cotton sales. At the same time, the fiscal deficit has been brought under full control by improved revenue mobilization and a reduction in interest payments on external public debt as a result of successful debt restructuring. The tight fiscal and monetary policies significantly reduced inflation: from 16.4 percent in 2003 to 7.1 percent in 2005. However, it has risen to 12.5 percent due to large increase in energy tariff and the inflows of remittances. The national currency has been stable through end-December 2006.

Despite those achievements, we fully understand that Tajikistan may face major challenges ahead. Our country remains vulnerable to external shocks and is still the poorest country in the CIS with an estimated per capita GDP of US$402 in 2006. This vulnerability is due to the fact that about three-forth of total export earnings remain concentrated on aluminum, cotton and electricity. And the remittances from abroad are the key trade deficit financing source and hence current account balance stabilization. Besides, our economy heavily depends on oil imports whose prices tend to further increase in recent years. These factors pose significant risk to maintain sustainability of high economic growth rate over the long-term. We recognize that lowered growth rate could increase the risk of debt distress because our external debt has recently increased. With this infrastructure investment in the transport and energy sectors needed to sustain economic growth. To mitigate such risks, the government intends to deepen structural reforms in all sectors to realize their full potential to sustain high economic growth rate and accelerate poverty reduction. We will also continue prudent management of macroeconomic policy, especially strengthening the management of external debt. We expect that implementation ofthe Public Administration Reform Strategy will lead to the gradual improvement in capacity in the government to implement key reforms.

In 2006, the Government has successfully implemented important policy reform measures that were agreed under the Programmatic Development Policy Financing (PDPF). We are committed to continue deepening the reform under the agreed agenda that will be implemented during the next few years.

I.SUSTAINING ECONOMIC GROWTH

The government attaches high importance to the growth agenda. In recent years growth performance has been strong, while in 2005 it slowed down mostly due to both external (world market prices for cotton, aluminum, and energy) and internal (in particular due to low cotton productivity, onerous regulatory environment for private sector development) factors. We understand that key reforms in this area should focus on: (i)improving investment climate; (ii)improving productivity of enterprises and agribusiness; (iii) increasing the efficiency in energy sector; and (iv) improving trade and air transport.

43 Investment Climate

Improved investment climate is considered to be an important agenda in private sector development policy of the government. Further actions in this area include streamlining and minimizing government interventions into business operations and reducing barriers to entry into the market. We acknowledge that those are major constraints for private sector development. Therefore we have enacted a new Law on Inspections and amended the existing Tax Code and also amended the licensing law. The measures are undertaken to bring regulations in compliance with these laws and relevant draft laws have been submitted to Parliament for approval.

We will pursue policy actions to enforce transparency and accountability in the privatization process. To ensure transparency of the privatization process and build support for the privatization program, we adopted a communication strategy that, among other things, mandates the publication of future asset sales as well as past privatized objects. The State Committee on Investments and State Property Management (SCISPM) has been publishing information on asset sales for previous periods and future assets. Further, we have completed a compliance review ofa set ofrandomly selected privatized objects for 2004. We intend to continue with the compliance review for the 2005 and 2006 privatization transactions.

Actions taken toward improving investment climate include:

Licensing and Inspections 0 We adopted regulatory documents on inspections, as well as amended current regulations on licensing selected types of activity. These regulations shall be clear and exclude any possibility for double-interpretation as well as facilitate the processes at the maximum. Besides, we will introduce administrative measures against those public officers that fail to observe new requirements for licensing and inspections. In the future, we will thoroughly monitor the implementation of the newly adopted legislation that governs activities requiring inspection and licensing to ensure their compliance and efficient execution.

Private sector development 0 The government has recently developed a pledge law for movable property and we are setting up a registry for such pledged assets in the Ministry ofJustice. This will facilitate secured lending where collateral is movable and thereby increase access of business to credit. We are currently developing a policy on property rights including for intellectual property and developing a draft investment law to provide clarity to and facilitate investors, in particular foreign investors.

In order to achieve sustainable development, we have developed a comprehensive private sector development strategy. Actions for the first three years have been incorporated as a PSD strategy to be implemented under the PRS. The salient elements of the strategy include reducing government related risk for businesses, barriers to entry, and the government related costs ofdoing business in Tajikistan.

44 Privatization We have made good progress in privatization. All small enterprises were completely privatized by 2001. Medium and large scale enterprises are still being privatized based on the 2003/2007 Strategic Privatization Plan. Enterprises have been grouped into three categories: Category One covers medium and large scale enterprises to be privatized through auction; Category Two covers large enterprises to be privatized through tender procedures; and Category Three covers strategic infrastructure and other enterprises. Those in the first and second categories are expected to be hlly privatized by end 2007. Restructuring plans have been prepared for the third group in order to attract private investments into these strategic enterprises.

0 The Government shall continue the current course to improve transparency and accountability of the privatization process. We will continue with annual random compliance reviews of privatized objects with an objective to disclose deficiencies in the privatization process. The specific steps in this area are as follows: (i)amendments to current regulations as needed to remedy deficiencies explored during the random compliance review of privatized objects; (ii) continuing random compliance reviews of privatized objects annually and adoption of necessary remedial actions through year 2007; (iii)continuing full disclosure and broad communications to the public on previous and future auctions and tenders; and (iv) adoption and implementation of individual restructuring plans of large state enterprises. We also plan a program on privatization of unfinished legacy which will allow their completion and efficient utilization by the private sector and, thus creating employment and sustaining growth.

Enterprise Productivity and Agribusiness

Improved competition rules and increasing productivity in agribusiness are expected to create a healthy competitive environment in local market and ensure sustainability of growth in medium and longer term. The Government adopted a new version of Law “On Competition and Limitation of Monopolistic Activity at Commodity Markets” in 2006, and issued a clear regulatory mechanism for execution of the new Law in March 2007. We also amended the Law “On Natural Monopolies” and are now preparing its implementation mechanism including the implementing regulations.

On agribusiness, the Government has adopted a Farm Debt Resolution Strategy which considers necessary actions to increase productivity and ensure fair distribution of export sales revenue in cotton sub-sector. The Ministry of Economic Development and Trade, and the Ministry of Agriculture and Environmental Protection towards increased flexibility and competition have prepared revised cotton pricing method (Methodica) for calculating the ex-gin price in Tajikistan. This allows to farmers to register contracts based on negotiated prices and to also register contracts with prices on the date of the contract. The government has also adopted a decree on moving to international cotton

45 standards; a joint venture has been established with an internationally recognized cotton grading company with compulsory grading and weight certification in next two years. We will continue the practice ofplanting High Yielding Varieties of seed cotton. These actions are expected to contribute to increased productivity in cotton sub-sector through greater competition in the sale as well as fair income distribution in the sub-sector.

Energy Sector Reform

Energy is one of the important sources of economic growth for the country. In January 2006 the government has signed Memorandum of Understanding with international financial institutions on future development strategy as well as new tariff policy and social protection mechanism. We have taken key steps to reform the energy sector including separation ofpolicy making and commercial operations, development of a new tariff policy, and revision of the existing social protection mechanism to protect the vulnerable groups from the tariff increases.

The Presidential Decree on separation of Open Joint Stock Holding Company "Barqi Tojik" from Ministry of Energy has been signed in March 2006. To enhance transparency further, we will ensure that Barki Tajik and Tajik Gas adopt International Financial Reporting Standards, implement the necessary accounting and financial management systems in their organizations, and have their accounts audited by internationally reputable auditors.

Under a new tariff policy, the electricity tariffs are being increased gradually according to a specified schedule during 2006-2010 until they reach the cost recovery level (of 2.1 cent per kWh for electricity at 2003 prices). The government increased gas tariffs in October 2006 and again in 2007 in line with increases in prices of gas imported from Uzbekistan.

We have introduced a lifeline tariff; eliminated the privileged class of consumers; and have been allocating since 2003 funds in the state budget earmarked to provide cash compensation to targeted consumers to meet their energy bills (electricity and gas). Budget allocations to compensate vulnerable groups for the increased tariffs were increased by 19 percent in the 2007 budget over what was spent in 2006. We will continue with the Energy Cash Compensation scheme until 2010, with refinements to improve its effectiveness. Furthermore, we will review the Social Protection mechanisms in 2009 with a revised Household Energy Survey to see if a revised social protection scheme is warranted.

Trade and Air Transportation

To improve the air access to the country, we have taken initial steps to reform the aviation sector. We will continue gradual move to open air policy. Since May 2005, a China Southern Airlines started operating on Dushanbe-Urumchi-Beijing route; Turkish Airlines has been operating on Dushanbe-Istanbul route since end-January 2006 and have now increased their frequencies to two flights a week.

46 We have separated policy making and technical regulation responsibilities and put at arms length by Government regulations. Also, the Government has also adopted a government resolution on restructuring plan of the State Unitary Aviation Enterprise “Tajik Air” for the legal, operational and financial separation of the operations of the airport, airline and air traffic control by end 2008. In this context, we have undertaken a financial review of the separate accounts‘and a comprehensive analysis of the cost structure of the company’s three business entities (airline, airport, and air traffic control) and developed a realistic timetable for separation ofactual operation. We will implement measures to strengthen capacity and the financial viability of each separate entity. All these actions together will ensure the more efficient operation of the sector and competition in it.

To facilitate cross border movements of peoples, the government has also begun to simplify the visa regime. We eliminated the use of Letter of Invitation as a requirement for obtaining a visa by citizens of OECD countries. We are adopting new rules for issuing visas for citizens of OECD countries upon arrival in Tajikistan. We have also liberalized the internal visa regime to reduce transaction costs for business and to increase flexibility in labor markets. We have also issued a decree to reduce internal checkpoints oftraffic police and thereby facilitating domestic trade.

We have made significant progress in actively pursuing a program of reforms to enable WTO accession. In particular, the government has reformed its custom administration procedures and revised the customs code to make it consistent with international standards .

11. IMPROVING PUBLIC SECTOR PERFORMANCE, PUBLIC FINANCIAL MANAGEMENT AND THE QUALITY OF SERVICE DELIVERY

Tajikistan is country in transition to a market economy and needs to create adequate public institutions to improve the quality of public services, one of our three strategic priorities set out in the NDS and the PRS. In this regard, high priority is attached to: (i) the implementation of the PARS; (ii)improving resource allocation by strengthening the link between mid-term and long-term government programs and budget planning; (iii) improving the efficiency in budget resource allocation in the education sector; and (iv) improving primary health care service by increasing transparency in budget management and increasing wages. We understand the importance of immediate actions in Civil Service Pay reform, strengthening horizontal civil service management and amending the “Law on State Service”.

Public Administration Reform

We have made good progress in implementing the Public Administration Reform (PAR) strategy since its adoption on 15 March 2006. The Government has taken important policy actions on selected key aspects of public administration and civil service reform

47 that will form a basis for creating an efficient public sector, thus supporting private sector development and improving basic service delivery. These policy actions include:

Introduction of an improved civil service remuneration system in all ministries and agencies in 2006. This remuneration system integrates all benefits and supplements, except for qualification rank and seniority increment, into a single base pay with moderate decompression of salaries. The Government of Tajikistan has adopted a resolution, effective April 1, 2007, to increase the decompression ratio to 1:4 between the salary of the first deputy minister and that of specialist. We are expecting to adopt a supplement budget in second half of 2007 that will ensure that possible increases in wages will be consistent with decompression policies. The scope ofcivil service is narrowed by revising the status of auxiliary staff as that outside the civil service.

Introduction of Merit-Based Recruitment and Promotion. As of April 2007, the filling of vacant posts in the civil service will take place in accordance with the new Regulation on competitive selection. We have begun developing job descriptions, essential for enabling merit-based selection, and initiated training of personnel managers to implement this Regulation throughout the civil service.

Creation ofa fully automated Civil Service Register, expected to be completed during the next few years;

Enactment of a new Law on State Service on March 13, 2007. The law includes separation of political and administrative positions, competitive selection of administrative officials - civil servants, simplified grading structure, enhanced responsibilities for the civil service management by the Civil Service Department, and mechanisms for performance incentives;

The capacity of the Civil Service Department will be further enhanced through technical assistance available through the Public Sector Reform Project;

Completion ofthe horizontal functional review of the central bodies ofthe executive in January 2007 that catalogues the functions of the central government bodies; recommends on refining missions and the functions of the central bodies; and identifies the functions to be outsourced, terminated or reallocated. The review enabled the government to introduce a new government structure following the presidential inauguration in November 2006.

Restructuring ofthe central government administration through the president’s decree 6 (November 30,2006) was implemented during December 2006-January 2007. The restructuring introduced a new government structure that separated the policy function from control and service delivery. It also reduces the number of ministries and state committees directly subordinated to the government. .

48 As a next step, we intend to develop a legal basis on the structure ofpublic administration to ensure uniform implementation of the functional separation to improve the effectiveness of the public administration. We recognized that legislation will establish the core principles and norms regulating the institutional system ofpublic administration and define the principles of organization, the types of government entities, their hierarchical status, and the accountability arrangements. In this context, we have established a working group within the Executive Office of the President to develop the concept for the structure of the public administration, measures for its realization, and a time-based action plan.

Strengthening Public Financial System to Improve Governance

We have made progress in reforming the public financial management system during the past several years. The reforms have improved functioning of our budget and treasury systems, thus increasing transparency and accountability of the public sector. However, we recognize that much remains to be done to further improve efficiency of public spending and thus the delivery of public service. We are committed to strengthening strategic budget planning by linking to sector policy priorities, modernizing budget and treasury management, strengthening procurement and public financial internal control, and increased independence ofexternal audit.

Intern a 1 Control

0 To improve public financial internal control systems, we adopted the Public Financial Internal Control Strategy adopted by the Government in March 2007. The strategy will support the development of a legal and institutional framework and building government audit capacity.

Public Procurement

We have improved legislative and regulatory framework of public procurement through adoption of a law “On Public Procurement of Goods, Works and Services” that is consistent with the international standards. We will gradually introduce the new law to decentralize public procurement agencies due to weak capacity of the central and local governments. A special inter-agency committee will be formed to certify the capacity ofthe procuring entities under the new law. Finally, we will introduce Standard Bidding Documents (SBD) and Implementation Regulations (E)to decentralized procurement unit in line ministries.

Fighting Corruption

Recognizing the negative influence of corruption on the quality ofpublic services and current business regulatory framework, the government is committed to taking serious steps to fighting corruption. A new Law on Fighting Corruption was adopted in 2005 and measures are being developed to fight corruption based on findings ofthe recently completed national corruption survey conducted by the Strategic Research Center with the support of UNDP. A State Financial Control

49 and Anti Corruption Agency reported directly to the President was created in November 2006. It is the only government structure dealing with fighting corruption, which consolidated the anti-corruption functions conducted by numerous entities and significantly eliminated their personnel. It will also increase efficiency and effectiveness in the use of scarce capacity in dealing with this very difficult task.

External Audit:

0 The Agency on State Financial Control and Fighting Corruption, established based on relevant abolished agencies, aims also at providing external audit functions. We understand the necessity and are committed to the goal of further developing external audit function based on the principles of openness and independence. With this goal in view, we will study the advanced practices of external audit based on which we will develop an action plan for institutional improvement ofthe independent external audit function. In the nearest future we will create a task force to develop a vision for an independent external audit function and develop a legislation framework. The Government will adopt a strategy and action plan on establishment of Independent External Audit Body by March 2008 and will initiate the development ofregulatory framework ofexternal audit functions according to agreement with IDA. In this work, we will use the recommendations reflected in Institutional Development Plan prepared under Cooperation Partnership Project between the Tajikistan’s state financial control body and the UK Supreme Audit Institution. We also hope to cooperate with the World Bank and other International Financial Organizations to learn more from the experience ofother countries in this area.

Strategic Policies and Resource Allocation Framework

The Government has strengthened the alignment of the public expenditure with the policy framework has improved. We ensured that the externally-financed Public Investment Program (PIP) and the budget-financed Centralized Capital Investment Program (CCIP) are aligned with the priorities and actions ofthe PRS for 2007-2009 and consolidated the PIP and CIP by creating a single Department of Public Investments at the Ministry of Economic Development and Trade. We intend to further align the recurrent expenditures with the policy framework and the PRS.

The adoption of an MTEF will contribute to efficient resource allocation within and across sectors. In September 2006, we adopted a MTEF action plan that lays out role and responsibilities of ministries and agencies, activities and a timetable for preparing the 2008 budget. Due to weak capacity, we have decided to implement the MTEF on an incremental basis beginning with the education sector to align the education budget with the National Strategy for Education Development (NSED). We recognize that implementation of the MTEF will require changes to the budget process and we are beginning to initiate these changes in collaboration with the Ministry of Education and local governments. We intend to expand the MTEF to other sectors over the medium term.

50 Resource Allocation in the Education Sector

The implementation of an ESS that includes a specific strategy on Education Financing (Per Capita Funding) is currently underway. Per capita funding of general education schools was introduced on a pilot basis in five rayons in 2005. Based on a positive evaluation ofthe original pilots, it has been expanded to seven new rayons in 2007. We have trained school and rayon administrators on financial management and to improve the monitoring system introduced last year. This expansion will help prepare the basis for scaling up at the national level.

We have recently commissioned a study on reforms of the wage system. The 2007 budget includes wage increases for education workers averaging 15 percent effective April 1, 2007. All supplements-except class leadership and textbook correction-are integrated into base pay effective in April 2007. This is a first step towards our commitment to a remuneration and promotion system that compensates education workers based on level of responsibility, qualification, and performance. As an integral element ofthe wage reform in the education sector, we will improve the stavka (teacher loads) system to ensure efficient use of human and financial resources. The Ministry of Education is expected to lunch a comprehensive study on stavka system with an objective of to bring them close to full-time occupation. We will also conduct a school census for the whole country in 2007 that will serve as a data and analytical base for improving the ministry’s capacity in formulation of evidence based policy, development of investment plans, better resource allocation including a rationalization plan for school facilities and for further roll out of per capita financing. The school census will support the establishment ofa national education management information system (EMIS).

Health Care Reform

The government adopted the Health Financing strategy in 2004 that aims at (i) establishment ofan institutional structure ofa single-payer for health care; (ii)pooling of sources ofpublic funds for free health care; (iii)development and implementation ofnew provider payment mechanisms; (iv) regulation of informal payments in the health system and introduction of formal co-payments; (iv) increasing health personnel salaries; (v) reorganization ofthe system ofhealth services delivery; (vi) improving equity ofresource allocation. In order to meet the goals of the strategy as well as guarantee access of the vulnerable population to basic health services, we will strengthen primary health care by increasing resource to primary care, implementing per capita funding, reintroducing the basic benefits package (BBP), introducing a new job classification and wage grid system for primary health care workers, and separating funding flows and accountability mechanisms between primary and secondary care.

In an effort to retain skilled health personnel in primary care, we are committed to allocate a greater share of the wage bill increase for primary care workers. Effective April 1 2007, we will use an asymmetric ratio of 54:46 to allocate the health’s wage bill increase to primary and secondary care, respectively. This will result in an increase in the wage bill for primary health care by 30 percent and secondary care by 10 percent. If additional budget become available n October 2007, we intend to allocate fund to

51 education, health, and culture. At that time, the allocation between PHC and non-PHC will be decided on the basis of the implementation of the BBP re-introduction in 4 pilot rayons. This is because we want to ensure that funds are available for the basic benefits package. In the future, we hope to maximize the reallocation of wage bill increase for primary health care. We will initiate the reform of a new job classification and wage system in the health sector.

The Government remains committed to the re-introduction of BBP. It initiated the BBP in summer 2005; however, the system was suspended in October 2005 due to design flaws. To ensure fully-funded package, the government will re-introduce the BBP in the same four pilot rayons where per capita funding is being introduced. The BBP currently includes free outpatient consultative visits and free primary health care visits. Subsequently, the Government will implement the co-payments for other services including hospital care based on the established timetable that phases the implementation of co- payments into two phases during 2007-08, after clarifying the structure and agreeing on the definition of co-payment. The Government recognizes that it will need to revise the structure of privileged categories-a combination of social groups, age, and diseases covering about 40 percent of the population-to ensure fiscal sustainability. We are conducting an evaluation of the BBP implementation to learn from the experience prior to implementing it oblast -wide and later nation-wide.

Finally, we will take further steps to implement financial management and accountability measures on level of medical facilities, both primary and secondary, improve criteria for resource allocation (per capita funding in health) as well as complete rationalization of medical facilities.

Conclusion

As the above indicates, the government ofthe Republic ofTajikistan strongly committed to undertaking necessary reforms actions to promote economic growth and improve service delivery. In this context, the support of the World Bank through approval ofthe Second Programmatic Development Policy Finance would be important to successful implementation ofthe government’s reform agenda.

Mr. President, we are looking forward to cooperation with the World Bank in implementing the above reform agenda.

Please, Excellency, accept assurances ofmy highest consideration.

Emomali Rahmonov

52 President Republic of Tajikistan r. ,Qura~6e 26anpena2007roaa

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Annex 3: Link between the Program, Analytical and Advisory Assistance, and other Bank nd Donor Programs Reform Area AAA Other Bank Operation Other Donors Macroeconomic Macroeconomic review PDPG operations DFID, EC, Switzerland, Japan management Licensing and Investment climate assessment PPIAF program Switzerland Inspections IFC small and medium-size IFC Business Enabling Asian Development Bank- enterprises survey Environment program (tax code modernization) Doing Business MIGA Foreign Investment USAIDiPragma-(licensing Advisory Service and registration) Privatization Program Investment climate assessment PPIAF program Switzerland, European Trade diagnostics study Commission. EBRD Doing Business Private sector strategy note Aviation Sector Reform Trade diagnostic study EBRD, Switzerland, Aviation study Energy Sector Reform Trade Diagnostic Study Energy Loss Reduction Project Asian Development Bank- Energy utility sector review Pamir Private Power Project (Power Rehabilitation) Central Asia regional China electricity export potential study Cotton Sector Reform Trade diagnosis study Farm Privatization Support Asian Development Bank Aviation sector study Cotton Sector Modernization USAID-Pragma Agricultural development Project Switzerland strategy Rural Infrastructure Project , DFID Poverty assessment update Community Agriculture and UNCTAD-(standards) Cotton sector review Watershed Management UNFAO-(land reform) Project, Land Cadastre project Ferghana Valley Development Project Public Administration Public expenditure and Public Sector Reform Project European Commission Reform institutional review (FY06) Asian Development Bank Public sector and civil service IDF Grant for Strengthening DFID wage note Civil Service Capacity Switzerland Programmatic public Public Financial Management TACIS-(public procurement) expenditure review Reform Project (FY07) Education for All-Fast Track Public expenditure tracking IDF Public Sector Initiative Catalytic Fund survey Accountability Public Expenditure and Institution Building and Financial Accountability Technical Assistance I1 (PEFA) Civil Service and Wage Country economic Public Sector Reform Project European Commission reform memorandum. Civil and public (FY06) Asian Development Bank sector wage policy note. Education Modernization Project Social Sector Reform Health sector policy note Community and Basic Health Asian Development Bank Poverty assessment update Project Sweden Health and education public Education Modernization Switzerland expenditure tracking surveys. Project European Commission Central Asia HIV/AIDS Project DFID Fast Track Initiative Trust Fund USAID Social Protection reform Grant Second Poverty Alleviation Project

79 Annex 4: Relations with the International Monetary Fund

The Bank's Country Partnership Strategy, endorsed by the Bank's Board of Executive Directors on July 26,2005, focuses on the following three priorities, which are in line with the country's PRSP:

0 To improve business opportunities in rural and urban areas a To enhance and preserve the quality ofthe human capital

0 To improve energy service delivery and increase electricity exports.

In addition, in each ofthe above areas, the Bank Group and government agreed to work to improve government capacity and efficiency, and reduce corruption by giving special emphasis to measures that increase transparency of resource use, reduce discretionary controls, and encourage the participation ofusers in the provision of services.

Macroeconomic management aims at establishing a stable economic environment through appropriate fiscal, monetary, exchange rate, and sustainable debt policies. In support of these policies, the authorities are tightening payment discipline, especially in the energy sector, hardening budget constraints for state-owned enterprises, and pursuing enterprise and banking privatization and restructuring. Recent improvements in macroeconomic management have supported the current economic recovery. However, to maintain strong growth the authorities will need to accelerate structural reform to support private sector development and investment, and encourage foreign investment.

The IMF has taken the lead in assisting Tajikstan in enhancing macroeconomic stability. The Fund has encouraged the authorities to continue with fiscal consolidation, maintain a restnctive monetary policy, and restructure external debt to enhance debt sustainability.

80 EXTERNAL RELATIONS DEPARTMENT

Public Information Notice (PIN) No. 07/44 International Monetary Fund FOR IMMEDIATE RELEASE 700 lgthStreet, NW April IO, 2007 Washington, D. C. 20431 USA

IMF Executive Board Concludes 2006 Article IV Consultation with the Republic of Tajikistan

On March 28,2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Tajikistan.'

Background

While the recent strong growth performance continued in 2006, inflation accelerated. Despite considerable disruptions to energy supply late in the year, real GDP growth reached 7 percent, fueled by a surge in construction activity and continuing strong remittance-financed demand for retail services. However, CPI-inflation reached 12.7 percent, its highest level since 2003, mostly because of failed harvests and higher gas prices, but also reflecting a relatively passive monetary policy stance. High aluminum prices and strong growth in nontraditional exports and workers' remittances did not translate into a commensurate improvement in the external accounts, as higher energy prices and strong demand for consumer and capital goods led to a surge in imports. Gross reserves remain relatively low, at the equivalent of two months of imports.

Fiscal policy remained prudent. Reflecting strong revenue performance and cautious fiscal management, the 2006 budget recorded a surplus, continuing the impressive fiscal performance of the past four years. While Tajikistan's external debt profile has improved significantly-mostly as a result of debt restructuring operations and relief under the Multilateral Debt Relief Initiative

' 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.

Washington, D.C.20431 0 Telephone 202-623-7100 Fax 202-623-6772 0 www.imf.org 2

-oncurrent trends, total public and publicly guaranteed debt is projected to increase significantly over the period of 2006-2009, mainly because of large project-related disbursements from China.

Progress in the structural reform area has been mixed. The authorities have been successfully implementing tax administration and public financial management reforms. While further headway has been made in strengthening the banking sector, it remains small and vulnerable, and public disclosure requirements continue to be inadequate. In the energy sector, important steps have been taken to align tariffs with costs; however, structural and regulatory weaknesses continue to undermine its potential. Agricultural reforms are on going, although finding a solution to the debt overhang in the cotton sector is still an outstanding policy issue. Enhancing growth prospects will also require improving the private investment climate. In this vein, the forthcoming second Poverty Reduction Strategy Paper is expected to address some of these issues.

Executive Board Assessment

Executive Directors commended the authorities for their progress in stabilizing the economy and their implementation of sound economic policies and structural reforms that have contributed to high rates of economic growth. Together with debt relief and macroeconomic stability, strong growth has led to significant progress toward meeting the Millennium Development Goals, including poverty reduction. At the same time, Directors observed that major challenges remain. Inflation pressures have resurfaced, debt sustainability could become a concern with rising indebtedness, and poverty remains widespread.

Directors commended the authorities for their strong fiscal performance in 2006. They urged the authorities to continue to implement a sound fiscal policy in 2007 and save any revenue overperformance, particularly since inflation is on an upward trend and the debt dynamics are worsening. Directors encouraged the authorities to refrain from adopting a supplementary budget until the inflation picture improves. Directors welcomed the significant progress achieved in the areas of tax administration, civil service reform, and public financial management. Nevertheless, the authorities need to address urgently remaining weaknesses in tax compliance and the financial monitoring of state enterprises.

Directors underscored the importance of controlling inflation. The macroeconomic policy framework should be buttressed not only by a strong fiscal position and a flexible exchange rate, but also by a tighter monetary stance. In this context, the balance sheet of the central bank needs to be placed on a firmer footing to give more flexibility and credibility to monetary policy. Directors advised the central bank to refrain from providing directed credits to the agricultural sector. Any financial resources directed to the private sector, particularly if subsidized, should be channeled through the budget in a transparent manner.

Directors supported the current managed float exchange rate regime, which they considered has served Tajikistan well. They encouraged the authorities to limit intervention in the foreign exchange market to smoothing operations and shoring up reserve coverage. 3

Directors observed that the authorities’ development strategy, centered on financing essential infrastructure investments through large and rapidly disbursing project loans at concessional interest rates, could entail risks to debt sustainability in the longer term if the expected concomitant acceleration in growth does not materialize. In addition, many Directors cautioned that the rapid debt accumulation could place additional pressure on the budget, as significant counterpart funds would be needed, which could reduce resources available for other priority sectors and affect macroeconomic performance. Against that background, Directors welcomed the authorities’ intention to put in place a debt management strategy that will prevent public debt from exceeding 60 percent of GDP.

Directors considered that the authorities’ medium-term growth objectives are ambitious but achievable. Reaching these goals will require determination on the part of the government to address long-standing policy issues in the agricultural and energy sectors, intensify efforts to improve the private investment climate, promote the channeling of the large volume of private remittances to the most productive uses, and enhance the governance framework for state- owned enterprises. Directors welcomed the authorities’ intention to focus the second poverty reduction strategy paper on efforts to improve the private investment climate and move forward with the public sector reform program.

Directors welcomed the authorities’ commitment to continue with the reforms of core macroeconomic institutions. They looked forward to even closer cooperation and discussion between the authorities and the staff in the period ahead, with a view to the design of a program that could elicit Fund support.

Public information Notices (P/Ns) form part of the IMF‘s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PlNs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PlNs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. 4

Republic of Tajikistan: Selected Economic Indicators

2003 2004 2005 2006 (Prel.1 (Annual percent change)

Production and prices Real GDP 10.2 10.6 6.7 7.0 CPI (e.0.p.) 13.7 5.7 7.1 12.7

General government Total revenues and grants 17.3 17.9 20.1 23.4 Total expenditure 19.1 20.3 23.0 21.7 Balance (incl. PIP) -1.8 -2.4 -2.9 1.7 Balance (excl. PIP & MDRI) 0.9 0.7 0.5 0.8

Monetary indicators Broad money 28.6 14.1 23.9 40.6 Velocity of broad money 11 3.0 3.7 3.5 3.3

External sector 21 Exports of goods & services 985 1,211 601 668 Imports of goods & services 1,142 1,451 1,221 1,646 Current account balance -20 -82 -58 -70 In percent of GDP -1.3 -3.9 -2.5 -2.5 Gross international reserves 135 189 224 252 In months of imports 3/ 1.8 2.5 2.1 2.0 Sources: Tajik authorities; and IMF staff estimates. I1Four-quarter average. 21 Starting from 2005, export and import figures reflect the transition to tolling arrangement for aluminum exports. Therefore, they show a sudden drop compared to earlier years. 31 Excluding electricity, which trades on a barter basis, and imports related to projects financed by loans from China. Annex 5 : Tajikistan Millennium Development Goals

Mi I lennium Development Goals Tsj,kistsn

Goal 1: halve the rates for $1 a day poverty and malnutrition Poverty headcountratio at $1 a day [PPP. %of population) Povertg headcountratio at national poverty line [X of population) Share of income or Consumption to the poorest qunitile (X] Prevalence of malnutrition(x of children under 51

Goal 2: ensure that children are able to complete primary schooling Primary school enrollment [net, X] Primary completion rate [x of relevant age group] Secondary school enrdlment (gross. XI Youth literacy rate [X of people ages 15-24]

Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education [X) Women employed in the nonagricultural sector (X of nonagricultural employment) Proportion of seats held by women in national parliament IX)

Goal 1: reduce under-5 mortality by two-thirds Under-5 mortality rate (per I.OOO] Infant mortality rate [per l.ti00 live births] Measles immunization (proportion of one-year olds immunized. XI

Goal 5: reduce maternal mortality by three-fourths Maternal mortality ratio [modeled estimate. per 100,000 live births] Rirths attended by skilled health staff [A of total]

Goal 6: halt and begin to reverse the spread of HlYlAlDS and other m Prevalence of HIV (z of populationages 15-49) Contraceptive prevalence [A of warnen ages 15-43] Incidence 06 tuberculosis [per 1UO.OtiO people1 Tuberculosis cases detected under DDTS [A]

Goal 7: halve the proportion of people without sustainable access to Access to an improved water suurce [x of population] Access to improued sanitation facilities (zof population] Forest area [A of total land area] Nationally protected areas (X of total land area] COZ emissions [metric tons per capita) GDP per unit of energy use [constant 2000 PPP $ per kg of oil equivalent]

Goal 8: develop a global pwt.crsbip for dcwtlopremt Fived line and mobile phone subscribers [per 1.000 people] Internet users (per 1.000 people] Personal computers [per 1.000 people) Youth unemployment (X OF total labor force ages 15-24]

~~ Education indicators (X) Measles immunization [x of 1- I IC1 indicators (per 1.000 people) gear olds) 100

::I25 0 2004 1'199 1195 ZOO0 2004 I znbo 2002 Fired t mobile subscribersL 0 Evropc k Ccntrrl Asia tnternct una15

Note Figures in italics are for years other than thosP specilied indicatesdata are not available 3126107

Development Economics, Oevelopment Data Group (DECDG]

85 Annex 6: Tajikistan at a Glance

~a~~~i~t~~at a glance 312610P Eanpg?8r CpraCll taw Ada ame

70 473 2'343 143 242% 29.m 20 01 18 ZE 64 31

25 1,945 1,361 3Mt 4.113 580 1.260 9.142 2,586

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86 Bafanae of Payments and Trade "(10 1 EnLX Governance indicators. 2000 and 2004 fUS$ *Fimns,l T@ei mercnandise rrpnrts (lab) 973 350 Tmal merchandise mpms &if] 717 1,336 VDIC~and accountability Natade in pdsanJ se~-.(ices -111 -876 Pallklcal stability '~JVorken'remttances and enrn~ensaiori)t amploti@es(i~eipt~f 78 1,810 Rcgufatory quality

Rulc af law Cumnt acc~~ntbalanos -52 -7f as a of GDP 48 -2 4 X Cantrol of corruptlo"

Resetves, including Sjnld oa 269 P 25 50 75 ioo

Central Gouernment Finmce an04 Country's pirrcntile rink (0-100) 0 2000 .b?AM,.dn.&*r,,,",*ljrC @dGff) Pevtenue 14 D 23 4 .Gwm K.uln.nn-Kr..i-flulrurrl,W.rl~B.nl. Tax revenue 13 s 16 6 Expense 18 n 21 3 Technology and Infrastructure 2000 2004 Cash surplus'defict -3 1 18 Paved mads (% of total) Highest marginal tax me [%) Fixed line and mobile phone Individual subscnbers @er 1.000 people) 38 48 Corpowe Hiph technology exports ("&of manufactured exports) 41 8 External Debt and Resource Flow {US$ &ns) Environment Total rkbt oikdandmg and disbursed 1481 2 1440 Q &ncuttural land (91 of land area) 30.8 30 4 Total &h.bt Jemx 1144 207 1 Forest area ('b of land area. 2000 and 2005) 28 26 Nationally pmtened areas (91 of land area) 42 HlPC and MOR1 debt relief (expected. flow) - w 1 Total debt (% of GDP) 135.5 48 0 Freshwater resoumes per capita (cu meters) 10.31 1 Total debt semice I%of exports) 15 e 34 0 Freshwater withdrawal (X of irnemal resoumes ?B 0

Foreign direct investment (na inflows) 0 70 CO2 emis5iuns per CapRa (rrn) 0.64 0 75 Portfolio equdy (na inflows] 0 0 GOP per und of energy use PO00 PPP 5 per kg of oil equivalent) 17 21 Composition of total erternal debt. 2001 bergy use per caprta of oil equivalem) 47 1 501

US$ mllllm5

Private Sector Develuument

Time required to start a business [days) Cost to start a business I%of GNI per capda) Time required to reginer pmperty (days)

Ranked as a major connraint to business (% of managers surueyed who agreed) Tax mes Tax administration

Stork marka sapdalizatiun (X of GOP) Bank branches @er 1DD,OOD people)

Note Figurer in ltalics are for years otherthan those specified 2DD5 data are prelimtnary estimates. indicates data are not available -indicates obsemation is not applicable

Development Economic%.Oeuelopment Data Gmup (OECDG). 87 Annex 7: Joint IMF-World Bank Debt Sustainability Analysis (Summary) Tajikistan: Joint Fund-World Bank External Debt Sustainability Analysis (March 2007)

DEBTSUSTAINABILITY ANALYSIS

This DSA updates the previous DSA prepared in early 2006 (see EBS/06/10). Since then, Tajikistan has received debt relieffrom the IMF under MDRI (SDR69.3 million), and also contracted US$604 million of debt from China to finance projects in infrastructure and energy sector. In addition the government of Tajikistan intends to contract US$400 million of debt from China to build a hydroelectric power station. Therefore, despite the MDRI relieJ debt distress risk has increased significantly and could be now classijied as high. Under the baseline scenario, the ratios of NPV of debt to GDP, exports, and revenue breach their policy-dependent thresholds in the medium term, but improve over time. The ratio of NPV of debt to exports, however, is projected to remain above the threshold throughout the projectedperiod. The breach of the thresholds is more severe under stress tests reflecting potential macroeconomic shocks, and signijicant additional borrowing. The ratios for debt service payments to exports and revenue are expected to remain below the thresholds under the baseline scenario. However, under stress tests and alternative scenarios, these ratios would also breach the thresholds.

DATAAND METHODOLOGY’

1. The DSA focuses mainly on external public and publicly guaranteed (PUBLIC AND PUBLICLY-GUARANTEED DEBT) debt. Government and government guaranteed debt includes debt directly contracted or guaranteed by the government: and partially includes public sector nonguaranteed debt.3 To the extent that the information on the stock ofprivate debt is available from the authorities (in 2005 the NBT started compiling inventory ofexternal private sector debt not guaranteed by the government), it is incorporated into the DSA. As for domestic debt, domestic securitized public debt stands at $53 million and consists of government securities in the amount of $47 million held by the NBT and government guarantees to finance cotton sector in the amount of $7 milli~n.~At present, given its small size, incorporating domestic debt into the analysis will not

1 This DSA was conducted jointly by Fund and World Bank staff and in collaboration with the authorities, using the debt sustainability framework for low income countries. It has benefited from Fund and Bank staff consultations with the ministry of finance during missions to Dushanbe in October-November 2006 and January 2007, and included a full reconciliation of debt data. The Low-Income Countries (LICs) DSA uses (a) the current year exports as denominators for estimating debt-to-exports ratio; (b) the WE0 exchange rate projections for estimating debt stocks and debt service; and (c) a 5 percent discount rate. 2 Tajikistan has some “disputed” government guaranteed debt from the period prior to 1998, when guarantees were issued in ad hoc manner; the estimated amount ofguarantees is about $50 million. In 1999, the issuance of guarantees was centralized at the MoF. The disputed guarantees were not included in the DSA given that exact terms, conditions, and government repayment obligations were not known at the time ofthis analysis. However, even if these guarantees were recognized as valid, given the small amount involved (about 6 percent of total public and publicly guaranteed debt at end-2006), including them in the DSA would not change the main results. 3Coverage ofpublic sector nonguaranteed debt is limited to debt on which debt service is likely to be assumed by the government.

However, given the large size of government deposits at the NBT, the NBT remains a net debtor the government.

88 materially affect the results of the DSA. However, in the future the evolution ofpublic domestic debt will need to be monitored closely with the view to incorporating it into the DSA.

11. Tajikistan’s External Debt Situation

2. Tajikistan has continued to meet its external public and publicly guaranteed debt obligations on a timely basis and to seek relief from its creditors. Since a large share ofloans has been provided on a consessional basis, debt service obligations remain manageable. In 2006, Tajikistan obtained rescheduling ofdebt from Iran-no debt service payments are expected until 2008 on US$25 million loan, and maturity is extended by two years to 9 years-and Uzbekistan- US$8 million of debt service payment in 2006 and 2007 are rescheduled to 2008.

3. Debt relief under MDRI and contracting of loans from China were two major developments in 2006 that affected the external debt situation in Tajikistan. In January 2006, Tajikistan qualified for debt relief from the IMF under MDRI and was granted debt relief amounting to SDR 69.3 million (US$lOO milli~n).~Following debt relief, however, Tajikistan contracted debt from China in the amount ofUS$604 million to finance projects in infrastructure and energy sector.6 While the debt was granted on concessional terms with 40 percent grant element, its size (25 percent of2006 GDP) and uncertainty regarding economic impact ofthe projects increased risks to debt ~ustainability~.However, with no disbursement on loans from China in 2006 nominal public and publicly-guaranteed debt debt-to-GDP ratio continued to decline, reaching 3 1 percent at the end of the year mainly on account ofstrong GDP growth.

4. In 2007, the contracting of an additional US$400 million of debt from China is expected to increase the risk of debt problems in the medium-term. The authorities have indicated that they are pursuing additional financing from China for construction of new hydropower plants. While concessional terms are expected, the exact details ofthe financing agreement have not been worked out yet. Regardless of the terms, the rapid accumulation ofdebt will further increase risks to debt sustainability (see the baseline scenario). It is estimated that following the disbursement ofloans from China, nominal PUBLIC AND PUBLICLY- GUARANTEED DEBT debt-to-GDP ratio will increase to 57 percent ofGDP by 2009, or by 26 percent in three years, remaining, however, below its 2000 level of96 percent.

5. Potential bail out of cotton sector by the government poses additional risk to debt sustainability. Political pressure has been building up to provide financing to agriculture (cotton sector), as reflected in the recent decision by the NBT to contract US$lO million debt for on-lending to agriculture. By various estimates the debt accumulated by the cotton sector ranges between US90and US$300 million. While the resolution ofthe debt issue has been on the agenda ofthe government, no clear cut solution has yet emerged. Given that the Government assigns high social importance to the cotton sector, there is a probability that the Government will assume the debt, at

5 Debt relief was granted on the basis that Tajikistan’s income per capita was below US$380 in 2004. Under MDRI, Tajikistan was provided debt relief on stock ofoutstanding debt as of end-2004. 6 $281.2 million loan was contracted by the government to finance the construction of the road connecting Dushanbe and the northern part ofTajikistan. Two loans-US$267.2 million for construction ofa North-South electricity transmission line and US$58.1 million for construction of Lolazor-Khatlon electricity transmission lines-were contracted for on-lending to Barki Tajik, which is expected to service the debt. 7 While preliminary indications are that the projects will increase Tajikistan’s export potential, a thorough analysis to assess the economic impact ofthe projects has not been undertaken yet.

89 least partially, or will subsidize future lending to the sector. This DSA tests the worst case scenario under which the government assumes 100 percent ofcotton sector debt under the assumption that the total amount ofdebt will be equal to $300 million.’

111. Baseline Scenario

6. The baseline scenario, developed on a cautious set of assumptions about economic policies and outcomes (Box l),shows that Tajikistan’s debt is sustainable, but is at a high risk of debt distress. According to the latest three-year average World Bank’s CPIA rating, Tajilustan’s policies and institutions are assessed as those corresponding to a “poor performer.”’ The debt- burden thresholds for countries in this category are: (a) NPV ofdebt-to-exports ofgoods and services of 100 percent; (b) NPV ofdebt-to-GDP of30 percent; and (c) NPV ofdebt-to-fiscal revenue of 200 percent. The relevant debt service thresholds are: (a) 15 percent ofexports ofgoods and services; and (b) 25 percent ofrevenues.

Box 1. Tajikistan: Macroeconomic Assumptions Real GDP is projected to grow at about 8 percent per year until 201 1, and at 6.5 percent between 2012 and 2026. This figure is slightly above its ten-year historical average of6.1 percent, but well below its latest five-year (post- Russian crisis) average of9.4 percent. Growth is driven by exports, FDI, and expanding nontraditional sectors (services, textile, and non-cotton agriculture), as well as continued inflows ofremittances. Export of goods and services is projected to grow at a rate of 10 percent through 2012, reflecting expansion in nontraditional sectors and strong external demand, and at 7 percent thereafter as economy will be expanding following investment in the energy sector and in response to stable macroeconomic environment and progress with structural reforms. The current account is expected to sharply deteriorate in 2007-2009 (to -15.3 percent ofGDP in 2008) due to an increase in imports financed by loans from China, but will improve in 2010 following the completion ofthe projects. Thereafter, the current account deficit, excluding loans from China is expected to remain at about 4 percent as imports and exports are expected to grow at the same pace and financing will be constrained to official financing on consessional terms and stable FDI inflows. The net foreign transfer inflows (driven by remittances), assumed to remain strong, will decline from 36 to 20 percent ofGDP from 2006 to 2026 as the economy picks up. The reserve coverage ofimports is projected to build up gradually to 3 months ofimports by 2026. The fiscal stance continues to be prudent. During 2006-2010, revenues excluding grants will increase from 19.3 to 19.5 percent ofGDP, and further to 21 percent by 2026. Expenditure, excluding foreign financed PIP, will increase at the same pace leaving fiscal deficit, excluding foreign-financed PIP and MDFU related spending, broadly unchanged. Official external loan financing (on consessional terms) is projected to peak at 15.4 percent ofGDP in 2008 and then decline to 4 percent by 2010 and remain at that level thereafter. fter 2012, the DSA assumes that no new grants will be disbursed during the projected period.

Although this is an unlikely scenario, this could also be a proxy for a stress test for additional consessional lending. There are indications that the authorities could continue to pursue additional significant project financing from China and other donors. Three-year average ofCPIA ratings is used according to recently issued guidelines on DSA for LIC (SMi061364). These guidelines aim at a more conservative and less volatile assessment ofrisk than that based on a single latest CPIA rating. For Tajikistan, however, the use ofthe latest CPIA ratings would not change the assessment ofrisk in this DSA. Indeed, according to the latest 2005 CPIA rating, Tajikistan is placed into a “medium performer” category implying higher policy dependent thresholds. However, even these thresholds are breached in the medium term--albeit by a smaller margin--pointing to increased risk to debt sustainability.

90 7. Under the baseline scenario, three of Tajikistan's external debt burden indicators are projected to breach policy-dependent thresholds following the rapid disbursement of loans from China (Table 1 and Figure 1). In particular, by 2009 the NPV of debt-to-exports of goods and services ratio will reach 186 percent, exceeding the threshold of 100 percent by a significant margin. The NPV of debt-to-GDP will be at 44 percent, also significantly exceeding the 30 percent threshold, and NPV ofdebt-to-revenue will reach 227 percent exceeding the 200 percent threshold as well. By 2026, however, these ratios are expected to decline to 136,23, and 107 percent, respectively. The NPV ofdebt-to-export ratio, however, while on a declining path, will remain above its threshold over the years, underscoring the importance ofimplementing the relevant structural reforms targeted at increasing the GDP and export potential ofTajilustan.''

8. External debt service ratios are expected to stay below their thresholds over the entire period. During the projected period, debt service payments continue to be manageable, with the assumption that all ofTajikistan's external public and publicly guaranteed debt has been contracted on consessional terms, albeit spiking during the years when principal payments on loans from China fall due. In particular, the NPV of debt-to-revenue ratio would remain comfortably below 25 percent, peaking in 2014 at 17 percent and declining thereafter to 11 percent. The debt service-to- export ratio will peak at 14 percent, slightly below the 15 percent threshold, but then decline to 6 percent.

IV. Alternative Scenarios and Bound Tests

9. The historical scenario is based on averages from 1998 to 2005, and thus reflects a period of macroeconomic consolidation, some progress with structural reforms, and debt reduction." During 1998-2005, the current account deficit was relatively small as financing was limited, and growth was high as the economy was growing from a low level. Therefore, under this scenario, not only do all debt burden ratios remain well below the threshold indicators, they also follow a downward trend throughout the projection period. While the scenario illustrates the importance ofpreserving macroeconomic stability, progress with structural reforms and continued prudent debt management, the scenario is not very useful as a benchmark against which the current debt situation can be assessed because both the conditions ofthe economy and its external environment have changed dramatically.

10. A scenario incorporating additional US$300 million borrowing on consessional terms in 2007 to bail out the cotton sector shows increased risk of debt distress compared to the baseline scenario. In particular, all ratios, except debt service-to-revenue will breach their respective thresholds. The ratios ofNPV of debt to GDP, exports, and revenue follow the baseline pattern, but exceed the thresholds sooner and by a higher margin compared to the baseline scenario. The ratio ofdebt service-to-exports breaches its 15 percent threshold in 2012-13, but then declines by the end ofthe projection period (Table 2 and Figure 1).

10 Substantially lower than projected net foreign transfer inflows in the outer years (for example, due to a deteriorating regional economic situation) would likely lower imports, exports, and real GDP growth, with a possibility ofthe NPV ofdebt-to-export ratio marginally exceeding its policy-relevant threshold in those years. 11 The 1995-97 period has been excluded from historical average scenario due to disruptions from civil war. The average values for the 1998-2005 period are caiculated for current account deficit, real GDP growth, GDP deflator in $ terms, export growth, net transfers and FDI to GDP ratios.

91 11. A high-investment low-growth scenario underscores the risk to debt sustainability of the current debt-based development strategy. Rapid accumulation ofdebt together with uncertainty regarding the impact ofinvestments financed by China on growth tests the robustness of the conclusions of the baseline scenario. This alternative scenario shows that if growth were to come at halfthe rate forecast by the authorities, all ratios, except for debt service-to-revenue, will breach and remain above or very close to their respective thresholds. Moreover, the ratio ofNPV of debt-to-export increases and becomes unsustainable (Table 3 and Figure1).

12. A relaxation of the authorities’ current prudent approach to contracting external debt only on consessional terms would lead to a deterioration of Tajikistan’s external debt indicators compared to the baseline scenario. If all new borrowing were to be contracted on less than consessional terms during the projection period, Tajikistan’s NPV debt-to-GDP ratio would rise substantially. Specifically, with the increase in the average interest rate on new disbursements by 2 percentage points, the NPV ofdebt-to-GDP ratio would rise to 50 percent by 2009 and slowly decline afterwards to 34 percent by 2026 remaining above 30 percent threshold throughout the projected period. The ratios ofNPV ofdebt-to-exports and debt service-to-exports would also rise to 2 15 and 19 percent, respectively, and remain above their thresholds at a roughly steady level during the projected period. The NPV of debt-to revenue ratio will peak at 261 percent in 2009, but then decline to 162 percent at the end ofthe projected period (Table 4 and Figure 1).

13. Bound tests show that adverse macroeconomic shocks would also have a profound negative impact on Tajikistan’s external position. In the event ofa combined shock (to real GDP growth, exports growth, FDI inflows), all ratios would exceed the policy-dependent thresholds by a significant margin. In particular, Tajilustan’s NPV ofdebt-to-GDP ratio would rise to 109 percent by 2009, falling below the policy-dependent threshold of30 percent only by 2026. The same shock would also significantly worsen the NF’V ofdebt-to-revenues ratio, which would jump to 565 percent in 2009 and stay above the threshold of200 percent until 2022. l2 The ratios of the NPV of debt-to exports and debt service-to-exports would increase to 53 1 and 44 percent, respectively, and while on a declining path, would remain above the thresholds throughout the projected period. Debt service-to-revenue ratio would also exceed the threshold between 2013 and 2022, but would decline below the threshold after 2022.

V. Conclusions

14. Tajikistan’s risk of debt distress has increased significantly and has become high. The results ofthe alternative scenarios and stress tests indicate that the debt sustainability situation could further deteriorate with negative macroeconomic shocks, borrowing on nonconsessional terms or incurring extra debt-even on concessional terms-in an attempt to bail out the agricultural sector, and could become unsustainable if growth associated with large prospective investment does not materialize. The DSA results thus underscore the need for the authorities to exercise extreme caution in incurring extra debt and vetting projects, malung sure that external resources are used productively. Sound macroeconomic policies and the acceleration ofstructural reforms, especially in the agricultural and electricity sectors, would also be essential for maintaining debt sustainability. By contributing to higher export and output growth, these measures would reduce Tajikistan’s vulnerability to exogenous shocks.

l2Since Tajikistan is a small open economy with a high share of exports-to-GDP, the debt-to-revenue indicator is an important measure of debt vulnerabilities.

92 Figure 1. Tajikistan: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2006-2026 (In percent)

NPVof debt-to-GDP ratio

-Baseline Most extreme test . . .- . .. Government assumes cotton sector debt - - Newpublic sector loans on less favorable terms High investment IowgroMh

at-m~o=Nm~"~"m"~,M~~~~0000 000000000000000000000 NNNNNNNNNNNNNNNNNNNNN

NPVofdebt-to-exports ratio 600 -Baseline Most extreme stress test 500 ...... Government assumes cotton sector debt New public sector loans on less favorable terms - - High investment lowgrowth 400

300

200

100 ______~~~___

0 at-mmo-~m ~~wm0-Nrnu.m~ oooo----f" --NNNNNNN 000000000000000000000 NNNNNNNNNNNNNNNNNNNNN

Debt service-to-exports ratio l/ 50 45 I 40 35

30 Government assumes cotton sector debt 2s - - Newpubllc sector loans on less favorable terms High investment IOUgrowth 20 L __-I -~~~~ - - - 7 - T*- 15 ______-__------'. IO ...... \ 5 I 01

Source: Staff projections and simulations. 1/ Spike in the ratio in 2006 reflects debt service to the IMF financed under MDRI.

93 Figure 1. Tajikistan: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2006-2026 (Concluded) (In percent)

NPV ofdebt-to-revenue ratio

-Baselme Most extreme stress test - - . - - .. Government assumes cotton sector debt - - Newpublic sector loans on less favorable terms High investment lowgrouth

oo~~~~""~~~""~o-Nm"~w\or- NNNNNNN 000000000000000000000 NNNNNNNNNNNNNNNNNNNNN

Debt service-to-revenue ratio 45 -Baseline 40 Most extreme stress test - Government assumes cotton sector debt 35 -

30 -

5 I W ,6~~~="2""~"""-"""""NNNNNN 000000000000000000000 NNNNNNNNNNNNNNNNNNNNN

Source: Staff projections and simulations.

94 0

999?9- P-mVIm-10br4

'1- 3 Ti *r-

o~qomom~-- ommom- N mmoo-ommoom m--nyo *%PO* -0 * NN -

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wwIIoI-: 00uri.ii ' -N NN Table 4. Tajikistan: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2006-26 (In percent)

Projections 2006 2007 2008 2009 2010 2011 2016 2026

NPV of debt-to-GDP ratio

Baseline 23 31 39 44 43 41 32 23

A. Alternative Scenarios

AI Key variables at their historical alerages in 2007-26 If 23 21 19 17 14 11 -4 -18 A2 New public sector loans on less fa%orable tmsin 2007-26 21 23 33 44 50 50 48 41 34 A3 Government assumes cotton sector debt 23 38 46 50 48 47 36 23 A4 High-investmentION -growh scenario 23 31 40 47 47 47 43 41

B. Bound Tests

B1 Real GDP growth at histoncal aberage minus one standard deviation in 2007-08 23 31 41 46 45 43 33 24 E2 Export value growth at historical arerage minus one standard deviation in 2007-08 3: 23 35 50 55 53 51 37 23 83 US dollar GDP deflator at historical average minus one standard deviahon in 2007-08 23 37 54 61 60 57 44 31 B4 Net non-debt creating flows at historical a\'erage minus one standard deviation in 2007-08 41 23 58 92 94 90 85 57 25 B5 Combination ofBI-B4 using one-half standard de! iation shocks 23 62 107 109 105 100 66 29 B6 One-time 30 percent nominal depreciation relative to the baseline in 2007 5i 23 43 55 62 60 58 44 32

NPV of debt-to-exports ratio

Baseline 99 132 168 187 177 176 155 136

A. Alternative Scenarios

AI Key variables at their historical averages in 2007-26 I/ 99 88 80 71 58 47 -21 -108 A2 New public sector loans on less fayorable tmsin 2007-26 2i 99 143 189 215 206 207 199 205 A3 Ciosernment assumes cottm sector debt 99 162 196 213 201 201 177 138 A4 High-investmentIoa-groWh scenario 99 138 184 215 217 223 232 289

B. Bound Tests

BI. Real GDP growh at historical a\prage minus one st;mdard deviation in 2007-08 99 132 168 187 177 176 15s 136 B2 Export value aorrqh at historical aierage minus one standard deviation in 2007-08 31 99 203 395 423 400 394 331 253 B3 US dollar GDP deflator at historical average minus one standard deviation in 2007-08 99 132 168 187 177 176 155 136 B4 Net non-debt creating flo\cs at historical average minus one standard deviation in 2007-08 41 99 249 395 399 374 366 279 149 B5 Combination ofBI-B4 using one-half standard deviation shocks 99 281 524 531 497 486 372 201 B6 One-time 30 percent nominal depreciation relatke to the baseline in 2007 51 99 132 168 187 177 176 155 136

Debt service ratio

Baseline 22 8 8 7 8 9 9 5

A. Alternative Scenarios

AI. Key variables at their historical a\erages in 2007-26 I/ 22 8 7 5 5 6 2 5 A2 Nea public sector loans on less faborable tmsin 2007-26 2, 22 8 9 9 10 II 16 18 A3 Go\ernment assumes conon sector debt 22 8 9 8 8 10 11 6 A4 High-investmentlox-grouqh scenario 22 8 9 8 9 11 14 12

B. Bound Tests

B1 Real GDP growth at historical alerage minus one standard deviation in 2007-08 22 8 8 7 8 9 14 14 B2 Export value gr0xTh at historical average minus one standard deviation in 2007-08 3/ 22 11 16 15 16 18 31 28 B3 US dollar GDP deflator at historical akeragc minus one standard deviation in 2007-08 22 8 8 7 8 9 14 14 B4 Net non-debt creating flows at historical average minus one standard deviation in 2007-08 I: 22 8 11 12 12 13 29 21 B5 Combination of B 1-B4 using one-half sandad desiation shocks 22 9 14 16 16 18 38 29 B6 One-lime 30 percent nominal depreciation relative to the baselme in 2007 5' 22 8 8 7 8 9 14 14

Me.morandum item: Grant element assumed on residual financing (i.e., financing required abobe baseline) 6. 29 29 29 29 29 29 29 29 -- Source Staff projections and simulations li Variables include real GDP growth, growth of GDP deflator (in U S dollar tennsj, non-interest current account in percent of GDP. and non-debt creating floas 2 Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the b;rseline., uhile grace and maturia periods are (he same as in the baseline 31 Exports values are assumed to remain permanently at the IOWKlevel. but the current account as a share of GDP is assumed to retum to I& baseline level after the shock (implicitely assuming an offsetting adjustment in import le\ elsj 4 Includes oflicial and prirate transfers and FDI 5, Depreciation is defined as percentage decline in dollar.local currency rate, such that it never exceeds 100 percent 61 Applies lo all slress Scenarios except for A2 (less favorable financing) in which the terms on all neir financing are as specified in foolnote 2

98 Table 4. Tajikistan: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2006-26 (Concluded) (In percent)

Projections 2006 2007 2008 2009 2010 2011 2016 2026

NPV of debt-tere\enue ratio

Bareline 125 165 204 227 218 209 159 108

A. Alternative Scenarios

AI Key rariables at their historical arerages in 2007-26 I/ 125 110 97 86 71 56 -22 -85 A2 New public sector loans on less favorable terms in 2007-26 21 125 178 230 261 253 2Jb 204 162 A3 Government assumes cotton sector debt 125 203 239 259 247 240 182 109 A4. High-in\estment lowgrowth scemrio 125 168 202 227 217 209 214 198

B. Bound Tests

€31 Real GDP growth at historical average minus one standard deviation in 2007-08 125 168 213 237 227 218 166 I I3 B2 Export value growth at historical average minus one standard deviation in 2007-08 31 125 188 265 283 270 259 187 I10 €33 US dollar GDP deflator at historical aierage minus one standard deviation in 2007-08 125 196 285 316 303 291 221 150 B4 Net non-debt creating flows at historical ayerage minus one standard deviation in 2007-08 4/ 125 311 481 485 459 436 286 118 €35. CombinationofBl-B4 using one-halfstandard deviation shocks 125 329 559 565 535 507 334 140 B6 One-time 30 percent nominal depreciation relative to the baseline in 2007 51 125 232 287 319 306 294 223 152

Debt senice-to-revenue

Baseline 28 10 10 9 9 I1 14 11

A. Alternative Scenarios

AI Key vandbles at their historical averages in 2007-26 1; 28 10 9 6 6 7 2 4 A2 New public sector loans on less horable terms in 2007-26 21 28 10 11 II 13 13 16 14 A3 Gosemment assnmes cotton sector debt 28 10 11 10 10 I1 16 12 A4 High-investment lor~~-groowthscenario 28 10 10 9 9 11 19 20

B. Bound Tests

B1 Real GDP growth at historical average minus one standard dwiation in 2007-08 28 10 10 9 10 II 15 12 82 Export value growth at historical average minus one standard deviation in 2007-08 3, 28 10 11 io 11 12 17 12 E3 US dollar GDP deflator at histoncal average minus one standard deviation in 2007-08 28 12 14 12 13 I5 20 16 BJ Net non-debt creating floas at historical average minus one standard deviation in 2007-08 41 28 10 13 15 15 16 29 17 E5 Combinationof 81-84 using one-halrstandard deviation shocks 28 11 15 17 17 18 34 20 86 One-time 30 percent nominal depreciation relative to the baselme in 2007 51 28 14 14 13 13 15 20 16

Source Staff projections and simulations 11 Variables include real GDP growth, growth of GDP deflator (in U S dollar terms), non-interest current account in percent of GDP, and non-debt creating Rows 21 Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline , %,bile grace and maturity periods arc the same as in the baseline 31 Expons values are assumed to remain permanentlyat the lowr level, but the cwent account as a share of GDP is assumed to return lo its bzeline level atleer the shock (implicitely assuming anoffsetting rdjutment in import levels) 41 Includes official and private lransfers and FDI 5; Depreciationis defined as percentage decline in dollar local currency rate, such that it never exceeds 100 percent 61 Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specifiedin footnote 2

99 Goal 1: Improve business opportunities in rural and urban areas Encourage equitable, labor- Reduce the cost ofdoing Reform business licenses, intensive economic growth, business. permits, and inspections and with an emphasis on increase transparency and exports and improve competition in the privatization governance. process. Reform aviation, cotton, and energy sectors. Reform the public sector. Goal 2: Improve the delivery of energy services and exploit the country’s hydropower potential Increase exports Increase competitiveness in the Reform cotton and energy cotton market. sectors. Improve financial viability in energy enterprise. Goal 3: Preserve and enhance the quality of health and education Support efficient and fair Allocate resources for education Support for the implementation provision ofbasic services and health more equitably. ofper capita funding in and target support to the Increase school completion rate education and health. poor population and improve learning Strengthen incentives of achievement. teachers to deliver quality Increase access to primary health education services. care by children and women Support for primary health care. childbearing age.

I I

100 68°E 70°E Rayons KAZAKHSTAN 39 Kulob 1 Tursunzoda 20 Murghob 40 Baljuvon TAJIKISTAN 2 Shahrinav 21 Nosir Khusrav 41 Moskva 3 Rudaki 22 Shahrituz 42 Shurobod SELECTED CITIES AND TOWNS 4 Hissor 23 Qabodiyon 43 Khovaling AUTONOMOUS OBLAST CENTER* 5 Varzob 24 Jilikul 44 Muminobod 6 Fayzobod 25 Khuroson 45 Pandjakent OBLAST CENTERS To 7 Vahdat 26 Qumsangir 46 Ayni Tashkent NATIONAL CAPITAL TAJIKISTAN 8 Roghun 27 Bokhtar 47 Shahriston 9 Nurobod 28 Kolkhozobod 48 Zafarobod MAIN ROADS To 57 10 Rasht 29 Jomi 49 Istaravshan Andijon RAILROADS Fergana 11 Tojikobod 30 Vakshs 50 Ghonchi

To ya Valley ar 12 Tavildara 31 Yovon 51 Spitamen JAMOAT (SUB-DISTRICT) BOUNDARIES Tashkent Taboshar D UZBEKISTAN yr To 13 Jirgatol 32 Sarband 52 Matchin 52 S RAYON (DISTRICT) BOUNDARIES 55 Andijon 14 Darvoz 33 Panj 53 Jabor Rasulob Kayrakkum 15 Vanj 34 Danghara 54 Kuhistoni Mastchoh AUTONOMOUS OBLAST BOUNDARY* Khodjand Reservoir Konibodom 16 Ishkoshim 35 Farkhor 55 Ghafurov OBLAST BOUNDARIES Chkolovsk 56 17 Roshtqala 36 Norak 56 Konibodom 48 53 To 51 58 18 Rushon 37 Vose 57 Asht INTERNATIONAL BOUNDARIES 40°N Bukhoro 49 19 Shughnon 38 Sovet 4058 °NIsfara Ura- To * Area with no oblast-level administrative divisions, SOGD Tyube Kyzyl-Kiya 72°E where rayons are under direct republic jurisdiction. 1 Tursunzoda 30 Vakhsh REGION 2 Shahrinav 31 Yovon To 50 KYRGYZ REP. Bukhoro 47 74°E To To 3 Rudaki 32 Sarband Osh Sary-Tash 0 20 40 60 80 Kilometers han 4 Hissor 33 Panj Pendzhikent Zeravs Ayni 54 45 e 5 Varzob 34 Danghara n g Pik Lenin 0 20 40 60 Miles 46 - R a Jirgatal' 13 l a i (7134 m ) 6 Fayzobod 35 Farkhor s A 10 r a n Rasht Pik Imeni Lake 7 Vahdat 36 Norak T 11 Ismail Samani Karakul' (7495 m ) 8 Roghun 37 Vose Komsomolabad 7 9 9 Nurobod 38 Sovet Region under 5 8 12 4 GHORNO- 10 Rasht 39 Kulob direct Republic DUSHANBE Obigarm 1 14 11 Tojikobod 40 Baljuvon subordination 2 6 Rangkul' 40 Kalaikhum Pik Revolution BADAKHSHAN (6,974 m) 12 Tavildara 41 Moskva Nurek 43 Vanj 15 20 CHINA 36 ng Rukhch A.O. P ta Murgab 13 Jirgatol 42 Shurobod UZBEKISTAN r Mu 3 j a a rgab 31 n B 44 a 14 Darvoz 43 Khovaling P m Lake 38 38°N 38°N 25 i Sarezskoye 34 18 r 15 Vanj 44 Muminobod 29 39 Kulyab s A k 16 Ishkoshim 45 Pandjakent 32 s 42 u 27 Kurgan- 37 To Tyube Alichur 17 Roshtqala 46 Ayni Qarshi 41 24 30 Moskovskiy 18 Rushon 47 Shahriston 22 19 Garavuti 35 m 28 Pa ir 19 Shughnon 48 Zafarobod Khorog KHATLON 20 Murghob 49 Istaravshan 23 33 Shahrtuz h 26 s h Pyanj REGION k Andarob Pik Karl Marx 21 Nosir Khusrav 50 Ghonchi 21 a V (6723 m ) 17 22 Shahrituz 51 Spitamen Vrang 23 Qabodiyon 52 Matchin nj To Pa Baghlan 16 24 Jilikul 53 Jabor Rasulov Ishkashim IBRD 33493R 25 Khuroson 54 Kuhistoni Mastchoh This map was produced by the Map Design Unit of The World Bank. MAY 2007 AFGHANISTAN The boundaries, colors, denominations and any other information 26 Qumsangir 55 Ghafurov shown on this map do not imply, on the part of The World Bank PAKISTAN Group, any judgment on the legal status of any territory, or any 27 Bokhtar 56 Konibodom 68°E 70°E 72°E endorsement or acceptance of such boundaries. 28 Kolkhozobod 57 Asht

29 Jomi 58 Isfara