68418 v2 I. Introduction A cursory study of Tajikistan’s legislation would lead the observer to the conclusion that farming in the country has been liberalized and land distributed with tenure based on long term use right. A farmer allegedly has the right to grow whichever crops he wishes and there are even regulations that specifically limit the powers of local government to intervene. There is a commodities exchange (TUGE) that is charged with monitoring input and output prices and ensuring that exporters remit full balances and pay due taxes. In theory, therefore, Tajikistan is toward the front of agricultural sector reform in the Central Asian Republics (CARs) and one would expect to see notable and regular growth in the sector (as in Kyrgyzstan, for example). However, a study of the actualities of the situation uncovers a picture far different from that painted above. While certain sectors appear to be starting to improve (horticulture for example) one sector appears to be in serious crisis—cotton. There have been several studies of the sector in the past two years, concentrating mainly on the alleged USD 280 million (latest NBT estimates) debt that has accrued since 1997. GOT points to the inefficiency of farming units and their bad management as being the main causes for the debt. However, if one considers the cotton sectors in similar countries such as Kazakhstan and Kyrgyzstan, one can see that they are flourishing, despite similar (or lower) yields and an almost identical production base. So what lies behind the perceived demise of the cotton sector in Tajikistan? In short form, the problem revolves around the current system of finance, production and sales of cotton. GOT point to the low international prices for cotton as being contributory to the current debt situation. We shall see in this study that, while prices have been lower in recent years, they have not been so low as to explain major losses being incurred. Many point to the inefficiency of the gins and that their outturn rates of 32% are causing major losses. However, even based on these ginning rates, the sector should not be losing large amounts of money each year. It is true that ginning rates in Kazakhstan and Kyrgyzstan are higher (at around 36%), but the effect of increases to these levels would simply make Tajik cotton growing more profitable, not stem losses. It is argued that yields in Tajikistan are so low that it is not possible to have profitable cotton operations. However, yields have been improving in recent years and are now around the 2.0 MT/ha for seed cotton. Yields in Kazakhstan and Kyrgyzstan, however, are either worse or similar to these levels, yet their farmers are profitable and production is increasing on a planted hectarage basis (especially in Kazakhstan). Previous studies have tended to study the cotton sector through the “prism” of debt. While they have highlighted certain problems in the sector, this leads to a presumption that the debt situation is a real phenomenon. In this study we have not looked specifically at debt, but instead reviewed the wider operational problems that exist (that then contribute to the “debts”). A separate report produced recently for the World Bank did look at the alleged debts. The main finding was that the donor community and the Government of Tajikistan should be extremely wary of placing credence in the debts as reported by investors and their financiers. In all of the farms studied there were missing revenues, overcharged inputs, misallocated debts and serious legal concerns as to the assignment and validity of old debt. The fundamental difference between the situation in Tajikistan and the other Republics that we have mentioned is the level of market competition. In the former there is none, in the latter there are totally free markets with a large number of participants. It is clear that the effect of the competition has been to raise farm gate prices for producers, as ginners compete to secure cotton supplies. Inextricably linked with this is the fact that the ginners, in order to be able to compete with each other, have dramatically increased the efficiency of their operations (as mentioned above). The main factor behind a ginner’s ability to compete on price for seed cotton is his ginning outturn. Simply put, if a metric tonne of baled cotton is worth USD 1,000, then a ginner who has a 32% gin outturn can offer to pay USD 320/MT of seed cotton. A ginner with an outturn of 36% can offer to pay USD 360/MT. In Kazakhstan and Kyrgyzstan these increases in efficiency have not been achieved through the investment of millions of Dollars; in fact, just the opposite, they are still operating gins that are up to -1- 30 years old. The ginners have simply renovated their gins, keep them supplied with consumable spare parts and manage them very carefully. They have not only been driven by the profit motive, but by the necessity to become efficient in order to survive in a highly competitive market. While gins have been privatized in Tajikistan, there is no active competition amongst them. In fact, competition in Tajikistan should be higher than in the other Republics—in Kazakhstan (which now has a similar sized crop to Tajikistan) there are 15 gins, whereas in Tajikistan there are around 40 gins. In the study we have systematically considered all the problems in the sector, some of which are creating inefficiencies and limiting sector returns. The main question, however, is what are the factors stifling competition in Tajikistan? The main problem is that the lack of collateral in the financing system led to the introduction of crop lien financing. This means that a farmer has to enter into a financing agreement with one partner (investor) and he is then tied to this partner for his inputs and sale of his outputs, which creates a regional monopoly. This system was also the initial starting point in Kazakhstan and Kyrgyzstan, but in those countries this has not led to abusive monopolistic practices. The reason for this is that the farmer had a free choice of which partner to work with in the initial instance and (while in breach of the agreement) could sell his outputs to another party. This created competition in initially securing clients for the ginners and also ensured that they maximized their purchase prices for outputs (in order to ensure that the farmers delivered their outputs). In Tajikistan, the above has not developed because of the intervention of local government authorities (hukumats). The hukumat effectively dictates to farmers which investor they will be working with and further strengthens this by only allowing one investor to work in each district (so there are no other alternatives). Therefore, the investor has no interest in minimizing the costs of inputs or maximizing the price for outputs, as they have no competition. The hukumat further manages the situation through the local law enforcement agencies by controlling the movement of seed cotton. It is little surprise, therefore, that farmers complain of over pricing, short and late delivery of inputs. Given the beholden situation of the farms, it is also of little surprise that the price they receive for their cotton is below levels that they should receive and that they have no opportunity to query their receipts and end of year accounting. Central government’s interest in the sector revolves around the revenue that they receive, which amounts to around 35% of the total tax revenues. The main source of income comes from the tax that is levied on baled cotton exports (10% of FOB value). In an average year this amounts to around USD 15 million and therefore GOT are determined to ensure that the production of cotton is maximized. There is a clear fear on behalf of the government that, were the decision to crop cotton left to farmers, then cotton production would drop and this would have a negative impact on the annual budget. While this concentration on cotton revenues is understandable, unfortunately the methodology that the government uses to control the export price has negative impacts. In order to ensure that there is no under pricing of exports (and hence tax evasion), they have introduced a fixed price (which removes the ability of exporters to maximize their revenues) and only allow sale on FOB terms (which reduces the number of buyers for Tajik cotton). The price formula which is being used also under-prices Tajik cotton and this is causing losses to the sector of around USD 12 million per year. Surprisingly, given the importance of the calculation and levying of the export tax, GOT has enabled exporters to effectively self-certify the quality and weight of baled cotton exports. It is interesting to note that, while the percentage quality splits appear to be in accordance with expected norms, the ratio of baled weights to seed cotton weights is very low. This would certainly suggest that there is a degree of capital flight and tax evasion being undertaken through the false declaration of weights. In specific cases that were noted during the study, these losses could be up to 15%, which would equate to a tax revenue loss in excess of USD 2 million per annum for GOT. Although yields have shown marked improvement in recent years, it should be noted that they are still only in the region of 2.0 MT/ha for seed cotton. There are many reasons for the relatively low yields in Tajikistan (which we have discussed in the report), but the main reasons appear to be seed and salinity. Since Independence little investment has been undertaken in seed breeding in the Republic. -2- While a number of state owned seed farms still exist, they suffer from a lack of finance and investment and it appears as though they have effectively ceased to develop new seed types. The ability to import seeds from other countries is hampered by a lack of suitable legislation (mainly protecting genetic ownership) and an unnecessary requirement for prolonged quarantine tests. The problem with rising levels of salinity (especially in the south of the country) is linked to the issue of land ownership, division and surety of tenure. In order to maintain salinity levels at acceptable levels, it is necessary to ensure that the field drainage systems are properly maintained. Due to the fact that an individual field system is often shared by a number of farmers, there is no clear responsibility amongst them as to who (or how) should clear the drainage ditches. Furthermore, many farms note they have insufficient funding to enable them to undertake such maintenance work. Of course, in a situation where a farmer is not sure whether his land use is protected for an extended period, he also has little interest in expending monies on the long term sustainability and management of the land. In view of the above and given the paralysis that the sector is suffering, is there a way forward that would enable GOT to maintain its revenues (and perhaps enhance them), would encourage investment from domestic and overseas sources and result in increasing returns to farmers and the sector as a whole? The answer, fortunately, is yes and it lies in relatively simple reforms. Firstly, the practice of crop lien financing should be removed, which will lead to competition amongst investors and remove the barriers to entry that currently hamper any new participants. Due to collateral and risk management requirements of financing institutions, a new form of pledge will be necessary in order to ensure that financing still flows to the sector. It is suggested that the most practical form of collateral available is land and legislation will be required to enable its pledge. While financial institutions fear the practicalities of selling land that has been seized under a financing agreement, there is clear demand for rental land. The land could therefore be rented until such time as the debtor had paid off the debt or it had been recouped from rental income. Linked with the above reform will be the necessity of removing local government’s ability to summarily take land back from farmers (in theory for “misuse”). While GOT argues that this provision is required to ensure that there is no land speculation and that vast tracts of land lie idle, there appears to be no basis to this fear. Indeed, if land is not sellable (as in the first stage of land reform in Kyrgyzstan), then there is no apparent logic to this provision. The removal of the crop lien and the ability to summarily remove land use right will also ensure that the previous GOT decrees limiting the power of hukumats will be able to be enforced. Without these “tools,” the hukumats will no longer have the ability to dictate cropping and business decisions to the farmers. The increased surety of tenure will increase farmers’ confidence and enable them to take a longer term view. In such a situation it is clear that they will be more likely to undertake necessary investment in and maintenance of their land holdings (such as drainage), which will have a positive effect on yields. Secondly, while maintaining its protection of its tax base, GOT should review and amend its pricing formula and allow for the sale of cotton on terms other than FOB. Indeed, due to the inequity of an FOB formula, the tax should actually be applied to an ex-works price. This might result in a reduction of the tax base in the order of USD 1 million, but this can be more than compensated for in the provision detailed below. The nature of the current pricing formula ties Tajik cotton to the Cotlook A index, which suffers from various problems (which we shall not discuss here). In order to attain prices that are actually applicable to Tajik cotton, GOT should increase the activities of TUGE and provide for actual baled cotton auctions. This will not only provide farmers with access to the international market place, but it will also lead to the creation of a purely Tajik pricing system. As in Turkey, TUGE should also register the prices of transactions concluded outside of the auction system (through the collection of information from Customs). Thirdly, GOT should reform, as a matter of some urgency, its current legislation covering the seed sector. This will enable the import of foreign seed types and genetics, which will have a major impact on yields and also the quality of Tajik cotton. It is also advised that the seed industry should be fully privatized, as this will enable the development of a vibrant domestic seed sector. It should be noted -3- that there is large potential to undertake regional exports of seed (specifically Afghanistan and Kyrgyzstan), providing a new potential source of export tax revenue for the government. Fourthly, GOT needs to reform its cotton classification and grading systems. Due to the fact that most cotton is traded internationally according to the USDA classification system, it is suggested that GOT adopt these standards as being applicable in Tajikistan. This will require re-training of state authorities, creation of a classification reference laboratory and eventually purchase of fully automated classification machinery (HVI). Most importantly, the responsibility of issuing quality certificates needs to be given to a new organization, which should be created as a joint venture with an internationally recognized, independent controller. The reason for this is that this will enable cotton to be actually traded on the basis of issued certificates, as these will be acceptable to international buyers. This is an important factor in the creation of a smoothly operating auction system. It is argued that the introduction of the new classification system might increase revenues by as much as USD 14 million in Tajikistan (although this seems a little optimistic). Certainly, the weighing and grading of baled cotton by the new independent organization will lead to increased revenues for the sector and, specifically for the government, who could expect to increase their returns in the order of USD 2 million from the export tax. Finally, the resolution of the current “debt” situation should be a matter of priority. An integral part of the approach to debt resolution has to be the cessation of the tying of the production of indebted farms to their “creditor” investor. Farms must be freed from this suffocating relationship, enabling them to source inputs and finance from the cheapest sources available and be able to sell their cotton to the “highest bidder.” Repayment of any negotiated and rescheduled debts should only be permissible through the payment of monies through the banking system against an agreed debt repayment schedule. Failure to introduce such a provision will mean that farms which are currently stuck with predatory investors will be extremely unlikely to be able to pay off their debts and will become stuck in a vicious circle of inability to pay. Negotiation and assessment of the level of debt needs to be executed in the manner proposed recently by the World Bank (i.e. a professional and independent body supported by the donor community). II. A Sector in Crisis? The current situation in which the Tajik cotton sector finds itself is relatively well documented in the ADB Debt Resolution studies. Total external “debt” to date of the sector is USD 180 million (as of September 2004). According to the 2004 ADB study, of this total USD 115 million is classified as seasonal debt, USD 15 million as repayable within 3 years and USD 50 million as bad, or overdue, debt. From this and other ongoing work, it is far from clear that these classifications are valid. According to GOT (as mentioned in their recently issued strategy) the debt situation has been caused by “low profitability, weak farm management, excessive borrowing, non-purpose use of financial resources and low world market prices.” In order to study the validity of this statement we shall look at current yields, the quality of cotton produced, the relationship of costs of production (COPs) to world market prices and other related issues. This study will seek to draw on previous findings and also look to highlight other issues that appear to have been major influences on the apparent demise of the sector. 2.1 Current cotton production, financing and sales system 2.1.1 Farming structure As mentioned elsewhere, land reform is an ongoing and contentious issue in Tajikistan. It began in 1992 with the “Law on land reform” which provided that spare land, not being used by the state farms (kolhoz, sovhoz), could be applied for by producers for the creation of dehqon (“private”) farms. The definition of what constitutes a dehqon farm has been defined over time, with the latest revision in April 2003 with the “Law on dehqon farms.” -4- Apart from the dehqon land “ownership,” there are household plots (normally attached to the family home, average 0.15 ha); Presidential plots (not attached to the home and granted to producers under Presidential decrees of 1995 and 1997, for the purposes of producing food for the family unit, average 0.12 ha); rented land (where producers rent land from the local dehqon or state farm, average 1.3 ha); and state farms, or more recently collective dehqon farms. This latter category was created by the government as a reform of state farms in order to speed up the reform process. They are usually around 1,000 ha in size and have a large number of collective producer members. Although members are supposed to receive membership certificates, few do and a recent survey by Action Against Hunger (AAH) noted that 64% of producers operating on such farms thought that they were still working on old state farms. In the above study (undertaken in southern Tajikistan), 99.3% of those interviewed had household plots, 70% held Presidential plots, 7% were renting extra land and 3.5% were holders of dehqon land (average size 17 ha). It is interesting to note that 92% of producers said that they did not know how to apply for dehqon land registration. Even if they did, the costs are prohibitive for many. Also, if a producer takes land under a dehqon registration, he will assume part of the debts that have previously been incurred by the state farm (in accordance with the size of the dehqon lands that he registers). Many of these debts were incurred in the purchase of capital equipment by the state farm, but the producer does not receive any ownership of these assets—only the debts attached to them. The producer’s choice of what to grow on his land is linked to the type of land that he is using. On private and Presidential lots, the producer has freedom to grow whatever he wishes. However, it was noted in the AAH survey that 50% of interviewees said that they had no choice of what to grow on rented lands and 100% said that they had no choice if they were farming on dehqon plots. The ADB have noted that 73% of dehqon plots in 2002 were sown to cotton and that this number is projected to rise to 90% by 2005. Despite various government decrees to the contrary and apparent freedom granted under dehqon farm law, it is clear that there is no freedom of choice about the decision on how many hectares of cotton are to be planted. GOT’s national annual cotton plan is distributed on a regional level, which is then allocated on a district basis. District government then allocates the number of hectares that each individual farm is expected to sow to cotton (which is based on a rough calculation of yields versus total seed cotton required). While the farms are theoretically free to choose their cropping, the control mechanism utilized by district government is that farmers will have their land use right revoked and given to another party if they do not sow cotton. The means to do this is enshrined in the district government’s decision that land is not being used properly. As there is no definition of what might constitute improper use, this power is open to flagrant abuse. 2.2 Financing and sales structure 2.2.1 Source of funds Following Independence, financing for the cotton sector was originally provided by GOT and executed through AgroInvestBank (AIB—the former AgroProm Bank) and Pakhtai Tojik (government agency in charge of cotton). Due to budgetary problems in 1997, GOT entered into a partnership with the Swiss cotton trading company P. Reinhart, who provided a reputed USD 70 million for the sector. Various international banks were involved in the transaction (the main one being Credit Suisse), with the transaction backed by a government guarantee. Repayment of the loan facility was to be executed through the export of baled cotton to Reinhart. In 1998 the financing system was fundamentally changed, with the removal of the government guarantee and the creation of a “commercial” financing scheme. This involved Reinhart becoming a major shareholder of AIB and the removal of Pakhtai Tojik from the financing scheme and their replacement with a number of local agents (referred to as financiers, futurists or investors). -5- Repayment of the loan facility continued to be through the delivery of baled cotton to Reinhart. In order to manage the financing risk and given the lack of available collateral at the farm level, an unofficial form of crop lien structure was introduced. The basis of this is the physical control of seed cotton movements at the district level, exercised by district government, mainly through the use of the local traffic police. In 2004, AIB passed about 80% of their financing and “debt” profile to a newly formed non-banking organization called Kredit Invest (KI). KI has a charter capital of USD 300,000 and clients with debts allegedly in the region of USD 100 million. KI has not simply been created for the purposes of debt recovery, but very much see themselves as operating in the future and increasing their volume of lending. They are currently establishing local branch offices in 23 districts and are keen to move to lending to farmers directly, as opposed to through the investor structure. AIB is increasing the size of its lending portfolio to cotton farms which have no existing debts. In the 2004 season they lent 5 million Somoni directly to cotton farms and approximately 7 million Somoni to input suppliers in the sector (around USD 4 million in total). In 2005 AIB intends to increase their direct lending to cotton farms to 13 million Somoni and input suppliers to 10 million Somoni (approximately USD 8 million in total). During the past three years a number of local financiers have also entered the market with funds sourced outside of the Reinhart/AIB/KI scheme. It appears that the majority of these funds originate from Russian cotton traders, banks and textile concerns. In the north of the country an IFC financed, input and credit supply organization was created—Sugd Agro Service. This organization also offers technical advice and assistance to farmers in the region with selling their produce. It lends approximately USD 1 million per year, 80% of which is in cash to farmers, who borrow on average USD 350 – 450. The interest rate charged is 1.33% per month and in the first two years of operation they had a 0% default rate. 2.2.2 Structure of annual credits th The legal format for the financing scheme introduced in 1998 was set out in Decree 369 (12 September 1998). Under the terms of this decree, farms were now expected to raise credits from AIB in conjunction with an investor. The main reason for inclusion of the investor was that they would be responsible for managing credits at the farm level, for the collection and processing of seed cotton and the delivery of baled cotton to AIB/Reinhart. The financing agreements are based on a tri-partite contract (AIB, financier and farm), which sets out the maximum amounts of finance to be supplied, related to the number of hectares of cotton to be sown. These agreements are subject to registration at the Commodities Exchange (TUGE). The farm undertakes to supply baled cotton up to the value of the financing that they have received under the agreement. Agreements do not provide for prices for inputs on a unit basis, nor indicative prices for the cotton to be delivered. For the 2003 season a new type of contract was introduced which enabled farms to deliver seed cotton as repayment for their financing. In some cases, these seed cotton contracts do give indicative prices for seed cotton, although final payments are often not in accordance with these prices. The reconciliation of the financing agreement at the end of the season is contained in an “Akt Sverkhu.” which is basically a statement of account between the farm and the investor. In order to show the continuing nature of the financing arrangements, the Akt details the debts of the previous year’s financing as a carry forward figure. The Akt also provides for the total amount of financing in the prevailing season, broken down according to the amounts of inputs supplied and a total charge for those inputs. In the case of cash or bank transfer payments, the value of the payments is entered in the Akt. -6- The Akt is then presented to the TUGE for their registration and review. The amount of financing and accrued debts determines the amount of cotton that the financier is allowed to export. The TUGE calculates the prevailing price for Tajik cotton according to a set price formula (in relation to the international price index) and this is then applied to the total amount of financing. During their review of the Akt, TUGE checks that the prices charged for inputs are in accordance with the price lists that they maintain. If the prices charged are in excess of their norms, then the amount of cotton that can be exported is reduced by this amount. 2.2.3 Choice of investor/partner at the farm level If a farm has outstanding debts to an investor then they have no choice—they have to keep working with that investor and there are two control mechanisms to ensure this. Firstly, a farm that wishes to work with a new investor or credit supplier needs to provide a certificate (issued by NBT) that shows that they have no debts to any parties. Secondly, using the above sanction of removal of land use right, district government can ensure that the farm works with the investor that is approved by the district government. For farms that have no debts, the situation is potentially easier. Once they can provide an NBT certificate, they are free to enter into a finance agreement with a new investor. However, it is clear that district government still has the ability to influence farms through the land use right system. The ability of farms to negotiate with district government and new investors very much depends on the individuals involved. It is interesting to note that the few farmers interviewed who were free of debts and appeared to have relative freedom of choice, were all socially well placed. Many of these farms actually chose to source their finance directly from finance institutions and then made the decision on which investor to sell their cotton based upon pricing at the time of delivery. Of course, the logistics and costs of moving seed cotton large distances meant that there was little price competition between investors and this limited the farms’ abilities to maximize their revenue. III. Current Problems in the Sector Given the alleged debt situation that pervades the sector, it is argued that the whole sector is inefficient and badly managed. Below we have set out a number of specific problems from which the sector is suffering and it is interesting to note that none of them are actually due to a total lack of efficiency or bad management. In brief, the sector is currently suffering from poor governance, conflicting and debilitating legislation, monopolistic abuse practices, lack of competition and a structure that is an anathema to the attraction of investment (be that domestic or foreign). In comparison, the cotton sectors of Kyrgyzstan and Kazakhstan (which have very similar conditions and a shared heritage) are currently thriving with notable investment, competition and strong farm gate prices for outputs. The question, therefore, is what are those things in the current make-up of the Tajik sector that are different? 3.1 Price of Tajik cotton One problem in Tajikistan is that the amount of revenue at the export and farm gate level is insufficient. From conversations with various members of GOT, it is clear that there is a concern as to why the price of Tajik cotton appears to have become discounted in relation to other growths from neighboring countries. Obviously, issues as to quality (discussed below) do play a role in the general price trends, but there are other issues more specific to actual pricing which we shall discuss below. 3.2 Pricing formula The price of Tajik cotton is fixed according to a price formula applied by TUGE (based on second grade cotton). This price is set as a discount from the international price by means of one fixed deduction and two percentage deductions. The formula is set out below: -7- - FOB price for Tajik 2nd grade cotton = “A” index – 4.5% - USD 60/MT – 5% The net effect of this formula is that, as the international prices rise, the discounts become bigger. However, the reason for the discounts is to bring the international price (CIF) back to a price at the port (FOB). Effectively, these costs (between CIF and FOB) are fixed and are not subject to the international price of cotton. Therefore, the price formula has an overly negative effect on prices as the international price rises. For example: - “A” CIF price at 50c/lb = 50*22.0462 = USD 1102.31 FOB price = (((50*22.0462)*.955)-USD60)*.95 = USD 943.07 This implies a CIF to FOB discount of USD 159.24/MT - “A” CIF price at 70c/lb = 70*22.0462 = USD 1543.23 FOB price at 70c/lb CIF = (((70*22.0462)*.955)-USD60)*.95 = USD 1343.10 This implies a CIF to FOB discount of USD 200.13/MT What we can see above is that the discount increases with the movement of the international price, even though the actual costs between CIF and FOB have not changed. Therefore, of the USD 440/MT increase in the international price, the Tajik seller loses almost USD 41/MT due to the nature of the price formula. It is arguable that the discounts that are applied are also too high. In Uzbekistan, for example, the standard discount from CIF to FOB is a total of USD 75/MT and this even includes the costs of financing of pre-payment for a minimum period of two months. In Figure 1 we have presented the differences in the Uzbek and Tajik pricing formulas as they apply over the 1995 to 2004 period. We have adjusted the Tajik base price so that it is representative of first, not second grade cotton. We have also adjusted the Uzbek price to deduct the costs of finance that are implicit in the discount. FOB pricing 2,500 2,000 $/MT Uzbek FOB 1,500 T ajik FOB 1,000 500 95 96 97 98 99 00 01 02 03 04 05 19 19 19 19 19 20 20 20 20 20 20 Figure 1 – FOB pricing As we can see, the differential between the Uzbek and Tajik pricing formulas is greater when the international price is higher. In the 1995 season, the differential reached almost USD 150/MT, whereas in 2002 it reduced to around USD 60/MT. If we assume a period average of USD 80/MT and an export of around 150,000 MT per season, we can see that the loss to the sector from this pricing formula is in the region of USD 12 million per year. 3.3 Set price Given that the cotton sector is no longer state run, the only reason for the government to monitor export prices is to ensure that they minimize capital flight. However, any such price monitoring -8- should operate as a minimum price indication, as opposed to a set price. It was noted by many parties that, while they had buyers who were prepared to purchase cotton at prices higher than the formula, they were unable to register these exports. Although it may not have been an intention of GOT, the situation today is that the formula price has become a set price and the sellers’ ability to sell at higher prices has been curtailed. 3.4 Ex-farm pricing It is clear from the official costs that are incurred between FOB and ex-works, that the total payments to GOT are USD 119/MT (based on an “A” price of 60 c/lb), with further deductions for transport and handling at USD 106/MT. It should be noted that a directive of the Ministry of Economy in 2003 set out maximum deductions for transport, but these appear to have been ignored by investors. In Figure 2 we have given a comparison between the basic international picture for a price for delivered ex-gin and the current situation in Tajikistan, with and without export tax. Ex-works prices 3,000 2,500 2,000 "A" ex-gin $/MT 1,500 T ajik ex-gin no tax 1,000 T ajik ex-gin with tax 500 0 95 96 97 98 99 00 01 02 03 04 05 19 19 19 19 19 20 20 20 20 20 20 Figure 2 – Ex-works prices As we can see, current revenues in Tajikistan are below the theoretical values that should be received. The most marked loss of revenue is for export taxation. The reason for the difference in the without tax scenario is due to the TUGE price formula and other deductions, which are in excess of international norms. 3.5 Baled cotton quality In the period immediately post-Independence, Tajik cotton was considered to be the premium growth from Central Asia. Exports were concluded with Korean, European and other high quality spinning markets and it was traded at a premium to other growths. Since 1997, however, Tajik cotton has been in increasingly lower demand from the high quality spinning markets and also been trading at a discount to other competing growths (some of the reasons for which are discussed above and below). With regard to problems with baled cotton quality there are a number of issues, as reviewed below. 3.6 Staple length uniformity The efficient operation of a modern spinning mill is dependent on many quality factors, but chief among them is the uniformity of the staple length of the cotton fibres. When this uniformity within bales and parcels of goods varies, the mill efficiency drops and therefore the cotton becomes in less demand. Tajik cotton is increasingly suffering from varying staple lengths and, while this maybe due to a number of factors (such as timely irrigation and correct ginning), it is felt that a large -9- part of this current problem is due to the seeds that are being used to grow the cotton. Over the past 10 years the genetic potential of these seeds has deteriorated and also there appears to have been quite a discernible cross contamination between MS (medium staple) and ELS (extra long staple) seeds. It is felt that the presence and contamination of the longer staple fibers in the baled cotton are mainly to blame for the uniformity problems. 3.7 Trash content A common complaint from traders of Tajik cotton (and mill buyers) is that the trash content of the baled cotton has increased dramatically over the past years. This can be due to a failure to pick cotton well (perhaps in an attempt to increase seed cotton weights to increase farmer returns) or can indicate a general deterioration of the condition of the gins. In any event, this is a distressing phenomenon, as it leads to a decrease in the willingness of buyers to purchase Tajik cotton. It should also be noted that the current grading/pricing structure of Tajik cotton does not really take into account the trash content of the fiber and is mainly related to the color. This means that ginners and farmers have little incentive to minimize trash content in their baled cotton. 3.8 Mixed qualities It is clear that the baled cotton from Tajikistan is suffering from a mixture of qualities in any one parcel of goods (which is referred to as a “lot,” generally made up of 240 bales). There are several reasons for this and usually start at the farm level, where farmers are not careful and mix different qualities at picking. This can be due to a laxity on their part or an attempt to increase their returns by mixing lower qualities in with higher ones and then receiving payment for the higher grade. Even if this has occurred, ginners can overcome this problem by stricter control of the storage of seed cotton on arrival and ensuring that the grades are separated. In the final analysis, the last control mechanism is that there should be classing of cotton on a bale by bale basis and creation of shipment parcels based on quality classification of the baled cotton. Unfortunately, the Soviet system provided for shipment parcels to be based on consecutive bales processed through the gin and not on quality and the Soviet system is still in use in Tajikistan. While the ginners attempt to sell on a differentiated price basis to take into account the mixture of qualities within a lot, this is of little use to a merchant or a mill, as they are unable to separate the bales into their qualities in the port or the mill. The net effect of this is that it reduces a buyer’s willingness to purchase Tajik cotton. 3.9 Bale condition A regular complaint from buyers and mills is that the quality of Tajik bales is substandard. This is largely due to the quality of the bale bands that are being used at present. Although European/Asian bands are more expensive than Russian bale ties, they are of a much higher quality. The main problem is that the ties that are currently being used rust very badly and this causes discoloration of the cotton; they also snap regularly. In the gins visited, it was noted that Russian metal ties were being used, as opposed to higher quality bale bands. 3.10 Role of Hukumats Despite legislation to the contrary, there is clear evidence that the local hukumats (both regional and district) have a dominant position in the decision making process of what is to be cropped on the agricultural lands in their areas. They exercise their power mainly through the provision in land usage certification that denotes that land parcels can be taken away from farming units if their use of the land is not in accordance with “normal farming practices.” There is little definition of what this might be and it implicitly gives the hukumat the power to instruct the farmers on what crops to grow. The question, therefore, is why do they exercise this function, despite legislation to the contrary? On the simplest level, it must be remembered that there is a national plan for the annual production of cotton and that this is allocated on a region by region and district by district basis. Therefore, it could certainly be argued by the hukumats that they are simply fulfilling instructions which they receive - 10 - from central government. The fact that this is in contravention to stated law is overridden by the plan that they have to fulfil. However, it should be noted that the hukumats also appear to instruct the farmers with which investor they will be working in any given season and that an investor’s operations in any given district are dependent on the decision of the hukumat. It should be further noted that (generally) only one investor works in any given district and that they tend to cover a number of contiguous districts. This means that farmers have no choice of partner and that there is no effective competition between investors in any one geographical area. The question here, therefore, is why the hukumats take an active (and controlling) role in this commercial issue. It can be argued that it is necessary to limit the districts to one investor as a means of stopping farmers from receiving finance and then delivering cotton to another party. However, this constitutes control of commercial risk by the public sector, which should not be encouraged and does not incentivize the investors themselves to improve their commercial operations. 3.11 Yields As we have seen above, yields in Tajikistan have been improving slowly over the past five years (from a production low in 1999). It is certain that the effects of the Civil War negatively impacted yields, as farmers’ production was disrupted and inputs were more difficult to procure. From interviews conducted, it is clear that pre-Independence yields had been in the region of 3.5MT/ha. The question therefore remains as to what are the main impediments to yield growth in the current situation. It should be noted, however, that farmers interviewed in the south of the country noted that their yields in 2004 had been in the region of 2.1 to 2.4 MT/ha—already a marked improvement. 3.12 Seed Nearly all farms interviewed noted that they had not received new seed since Independence and continued to plant the seed from the previous season. It is clear that the genetic potential of this seed is by now severely reduced and that this is affecting yields. While there continues to be State run seed farms, it is not clear to what degree they are operating on a commercial basis or what their production levels are. 3.13 Quality of inputs All farms interviewed noted that the quality of inputs is bad. Obviously, the application of low quality inputs has a negative impact on yields. Farms were not able to actually assess the quality of the inputs themselves, because there is nowhere for them to have the inputs tested. While the inputs are tested for their quality at the time of import or manufacture, it is highly likely that they are subsequently diluted or altered before delivery to the farms. Farmers noted that better quality inputs were available in the commercial market place. Their problem is that they are bound to the deliveries from their investor partners and are not able to purchase in the commercial market place. 3.14 Timeliness of input delivery Even if the quality of the inputs is low, failure to apply them in a timely manner during the growing season has a further impact on seed cotton yields. Nearly all farmers interviewed noted that they failed to receive critical inputs in a timely manner. It does not appear to be the situation that the inputs are not actually available in Tajikistan, as farmers noted that it would have been possible for them to purchase the inputs at the required times from the commercial sector. The problem, as above, is that they are bound to their investors. - 11 - 3.15 Cost of inputs Due to the perceived costs of inputs supplied by investors (i.e. more expensive than the commercial market), many farms are using reduced amounts of inputs in an attempt to increase their profitability. This is not a necessarily prudent method of reducing unit costs, as the drop in yield may outweigh the cost savings. On average, it appears that the difference between the commercial market price and that charged by investors may differ by as much as 30 to 40%. It should also be noted that the farms, if they were able to buy in the commercial market, would be able to advance bulk buy and therefore benefit from further reductions in the seasonal spot price markets. 3.16 Salinity Many of the cotton producing areas of the country are now suffering from marked salinity. This is largely due to the lack of repairs and maintenance to the irrigation and drainage systems on the farms. During the Soviet times, the on-farm drainage canals were cleared on a three year annual rotation, however many farms have done little or no maintenance to these systems since Independence. There are many reasons for this lack of maintenance, although chief among them is the fact that the farms simply do not have the resources (mainly financial) to undertake the work. The other main factor is heavily linked to the issue of land tenure—if a farm does not have a clear or dependable title (or usage rights) for the land, then they are very unlikely to invest the time and money in maintaining such infrastructure. It should also be noted that this is also a difficult issue when one considers land that has been divided between a large number of farmers and where there is no clear responsibility between them for the maintenance of what, in effect, is a public good. 3.17 Weather While this is a general risk to farmers throughout the world, when assessing the implied yield data, it is important to note that in some years farmers’ yields have been adversely affected by weather, as opposed to fundamental problems with their growing operations. For example, at one farm interviewed in the Tursonadze District, they noted a yield in 2004 of 2.3 MT/ha, whereas in 2003 their yields had dropped to 1.6 MT/ha. This decrease in yield, they opined, was purely due to the fact that there had been rains after planting and that they had had to replant nearly all of their land (incurring extra expenses, suffering from a decrease in yield and seed cotton quality). Therefore, while their achieved price in 2003 was good, their collapse in yield and quality meant that they had suffered a loss. 3.18 Export Tax The cotton export tax is 10% of the TUGE prevailing FOB price indication. However, the actual value of cotton that the exporter actually receives is a FOB price net of costs from ex-works to FOB. Effectively, therefore, the tax is also levied on the exporters’ costs. While the international market price for the cotton is subject to change, the costs of transportation and other related services are relatively constant. Hence, the tax creates a worrying distortion and extra costs to the exporter and, therefore, to the sector. Moreover, the implied rate of taxation is higher than the 10% as set by GOT. For example, at 70c/lb CIF for first grade cotton, the implied taxation rate on an ex-works basis is 12.6%, whereas for 5th grade it is 13.2%. More concerning is that, as the international price of cotton decreases, the implied taxation rate actually increases. For example, at 50c/lb CIF for first grade cotton, the implied tax rate on an ex-works basis is 13.4%, whereas for 5th grade it is 14.3%. The net effect of this tax system is that, as international prices fall and/or quality is lower, the implied rate of taxation actually increases. This is obviously very alarming, as in both situations, the sector’s profitability is falling, yet its tax burden is increasing. This is a distortion that needs to be addressed, as it is placing a severe burden on a sector that is already only marginally profitable. - 12 - The Presidential Decree of May 2003 stated that, for all purposes, the date of the price fixation for a shipment of goods was to be considered the date of the payment for the goods. Prior to this, the date of actual shipment of the goods (as evidenced by the rail stamp on the bill of lading) was considered to be the fixation date. While this change appears to have been adopted by the TUGE, there appears to remain an anomaly, in that the tax authorities still consider the date of shipment to be the date for assessment of the cotton export tax. As payment has to precede shipment, this leaves exporters with a further exposure to changes in the international market. For example, if the price rises in the intervening period, the exporter has to pay the increased value of the tax, or will not be able to ship the goods. The price he receives from the buyer, however, was fixed at the lower price and therefore the implied rate of taxation actually rises again. 3.19 Combined effect of price and yields—revenue versus COPs We have mentioned above the various problems with the Tajik pricing system, the cost to the sector of the export tax and the prevailing yields. In Figure 3 we have presented the relationship between these factors and how they compare with the costs of production. We have used an international price comparison based on 36% ginning outturn and the Tajik situation of an outturn of 32%. We have assumed a cost of production (COP) of USD 200/MT for the period. While a stable COP is not realistic (given inflation in costs in recent years), we have used a stable figure because yields have been increasing in recent years (which would compensate for increases in costs). At a current COP of USD 200/MT of seed cotton and a yield of 2.0 MT/ha, this implies totals costs of production of USD 400/ha, which is in accordance with the current situation in Tajikistan. Figure 3 – Seed cotton prices Seed cotton pricing 900 800 700 "A" seed cotton 600 $/MT 500 T AJ seed cotton 400 T AJ no export tax 300 COPs 200 100 0 95 96 97 98 99 00 01 02 03 04 05 19 19 19 19 19 20 20 20 20 20 20 What we can see from the above is that, despite the export tax, the low ginning rate, high deductions and arguably low yields, cotton farming in Tajikistan was only unprofitable in 2002 based on the above assumptions. Given this picture, it is yet again hard to comprehend the argument that the sector currently finds itself in a position of severe debt. Furthermore, based on the price levels prior to 2001, it is almost inexplicable how the sector could have been in so much debt prior to 2001. 3.20 Terms of Sale 3.20.1 Delivery terms Currently an exporter of cotton from Tajikistan is only able to sell his cotton on FOB terms. International buyers wish to buy cotton on a number of delivery terms, for example: ex-gin, delivered at frontier (DAF), delivered duty unpaid (DDU), etc. The reason for this is that there are a number of - 13 - shipping destinations to which traders sell (or they may simply want to warehouse cotton at a destination for the purposes of speculation). However, it is not possible to purchase on these terms and, therefore, there is much less demand for Tajik cotton in comparison with other growths (which has a negative impact on prices). For example, the demand for cotton in the Russian spinning market has been increasing dramatically in the past few years and general prices can be in the region of “A” index minus USD 55/MT (or better). This represents a serious premium to the current FOB discount, but is not a term on which an exporter can sell Tajik cotton. Therefore, an exporter cannot sell to a trader who requires another delivery term, nor can he deliver to a mill buyer at a destination other than the port (upon which terms they do not buy). The other reason for traders purchasing on other delivery terms is that they wish to control their own shipping and many feel that, without this ability, their risk of default on delivery is too high and, consequently, they want to buy at a higher discount. 3.20.2 Time of fixation An exporter is only able to fix the price of his cotton at the date of receipt of the pre-payment for that parcel of cotton. This means is that he is totally unable to hedge his price risk. Given the current nature of the fiber contracts for farmers, it effectively means that the farmers are left with total market exposure from the time of delivery through to date of receipt of pre-payment. Where an investor has bought seed cotton, he is unable to lock in a sales price and is therefore at total market risk until he receives pre-payment for the cotton. The outcome of this is that the management of the market exposure is left with the international buyer, who is invariably the most knowledgeable party in the transaction (i.e. they will time their pre-payment to coincide with the lowest point in the market). If exporters were able to fix the price of their sales contracts in advance, they would be able to manage their price risk and potentially achieve better prices for their cotton. For the buyers, the ability to fix prices in advance gives them the opportunity to hedge their open position on the futures markets and therefore lock in their profits, potentially enabling them to pay better prices for the cotton. IV. Method and Bureaucracy of Sales 4.1 Improper use of TUGE While the role of TUGE at present is licensing/price monitoring, they have the ability to undertake baled cotton auctions. In fact, in 2003 they held some auctions for the sale of ELS cotton, as there was no demand based on the quoted prices and, as a result, a decision was made to hold open auctions. However, with the increasing availability of cotton free from debt and therefore available for free sale, the role of the Exchange should be stressed to private farmers as a means for them to be able to sell their cotton. Unfortunately, it does not appear that many farmers are aware of the ability to sell through auctions and thus decide to sell to middle men. The ability to successfully capitalize on this system is linked to the ability to sell cotton on ex-warehouse terms. Apart from benefiting the smaller farmers by providing them with direct access to the international market place, the other advantage of such baled cotton auctions would be that they could be used to create a real indication of the price of Tajik cotton. At present, there is no separate quotation under the “A” Index for Tajik cotton and instead the Central Asian quote is used. If the quality problems can be addressed, it is likely that Tajik cotton will become considered a premium cotton from Central Asia and would therefore trade at a premium to the Central Asian quote. The existence and operation of a baled cotton auction system would be a cornerstone to the creation of a separate Tajik quotation. 4.2 Lack of competition Quite simply, the past financing structure has led to the pre-dominance of one international trader in Tajikistan. While there were clear reasons for this and benefits from the fact that they were able to - 14 - provide financing for the sector, the situation has led the vast majority of other traders to leave the market. This means that there is less demand for Tajik cotton and, significantly, less positive pressure on the price that Tajik cotton is sold for. 4.3 Bureaucratic procedures Before customs clearance can be obtained for a shipment of cotton a total of seven documents needs to be obtained. It is well documented that obtaining these documents is far from easy and that there is a notable degree of rent seeking at all levels. The net effect of this situation is that, even when a buyer has concluded a contract for the purchase of baled cotton, there are continual delays and uncertainties as to the actual date of shipment. One of the most important factors for a buyer is certainty and timing of delivery and, as a result, many international traders have decided not to purchase from Tajikistan. Equally, the difficulties of the system mean that only a limited number of sellers have the ability to work within the system and this has therefore disenfranchised the farmers from selling their cotton direct to international buyers. 4.4 Quality grading system Tajikistan currently operates the old Soviet grading system (as do Kazakhstan and Kyrgyzstan). There are several drawbacks to this system in relation to price: a) Effectively the system only provides for discounts according to the color characteristic of the baled cotton, but does not provide for premiums or discounts to the color basis for trash content, preparation or nep (immature fiber) content. It is possible to argue that a move to a more sophisticated grading system could bring a net beneficial effect to the sales prices of Tajik cotton. b) Most mills buy from international traders according to the USDA grading system and use the HVI testing system. It is possible to argue that the introduction of such grading and testing systems would increase demand from mills direct and increase traders’ willingness to buy from Tajikistan. However, it should be noted that the effectiveness of such systems is dependent on the issuance of accurate and independent quality certificates and also the sale of cotton according to quality, as opposed to the traditional lot system. 4.5 Ginning Many reports on the sector refer to the fact that ginning is a major problem in the country. While the vast majority of gins in Tajikistan are at least 20 years old, it should be noted that this is not necessarily a factor that affects ginning outturn. If the cotton has been handpicked and the main spare parts (ginning saws) are of a reasonable operational quality, a gin in Central Asia will reach a standard ginning outturn of 31-33%. In Kazakhstan, the same types of equipment and of a similar age are achieving regular outturns of 36-38%. It should be noted that the quality of the cotton is similar and is also handpicked. If one calculates the implied ginning outturn in Tajikistan from the seed cotton and baled cotton production statistics, then one achieves a number in the region of 26-28%. However, interviews with ginners and farmers indicate an actual ginning outturn in the region of 32%. Certainly, inspection of ginned cotton seeds and gin motes would also indicate that the ginning rate is in these higher regions. The main impetus for ginners to increase their ginning outturns is either where they are a service provider paid on baled weights or where they are market speculators purchasing seed cotton. The higher their ginning outturn, the better the prices they are able to offer for seed cotton and, consequently, the larger the share of the market that they will be able to control. In Tajikistan, - 15 - however, ginners operate in regional monopolies and thus their incentive to invest to achieve outturns of 36 -38% are drastically reduced. It is clear that ginners currently suffer problems with their electricity supply, although this situation is improving (especially in 2004/5 season in the south of the country). However, ginners do have the option of being able to power their plants through generators. Many of them choose not to do so because they feel that the costs of the diesel required far outweigh any benefits that they might gain from a quicker ginning season. In fact, given the large number of gins in Tajikistan (approximately 40) most of the gins are not operating at full capacity in any event. However, if we consider the potential loss of revenue to the sector in comparison with current ginning outturns (32%) and those being achieved in Kazakhstan (36%), we can see that there is a potential to increase baled cotton production by 20,000 MT, or USD 14 million on an ex-gin basis. What one must note, of course, is that this sector is now privatized and therefore there are no direct interventions that can be undertaken by GOT to improve this situation. As we have mentioned above, the main impetus for ginners to increase their outturns is where they are competing with each other. The only measures open to GOT to improve the ginning sector is to introduce and encourage competition. 4.6 Legislation The question may be asked whether the current problems are caused by a lack of legislation and whether the answer is therefore the introduction of more government provisions to ensure better operation of the sector. What is clear is that there has been legislation passed which prima facie protects the interests of both investors and farmers. In fact, the provisions of the Presidential Decree of 15 May 2003 clearly set out a framework which should ensure relatively efficient relations between farmers and the investors. The problem appears to be that the monitoring of the implementation of the current provisions is institutionally weak. The weakness is caused partly by a lack of resources, legal loopholes, failure of government officers to execute their functions according to the law, and failure to integrate the roles of different ministries. On the other side, it is clear that many farmers are unaware of their rights and the effect of the legislation and the protection that it affords. Equally, even if farmers are aware of the laws, they feel unable to seek redress against their investors through the economic courts. The reason for this is that they have no confidence of the transparency of court decisions and also fear that such actions will lead to the investor refusing to work with them in the future. This last fear is overriding, as the farm will not be able to work with another party because of the hukumats’ preclusion of multiple investors working in any one district. 4.7 Monitoring An analysis of the main statistics shows a number of anomalies with regard to both quality splits and the volume of exports. It is contended that these anomalies are due to a lack of sufficient monitoring by GOT of the export and production system. Two specific examples have been detailed below. 4.8 Quality certificates Certificates attesting to the quality of a given party of goods are issued by the quality assessor of a ginning factory. The assessors obtain a license each year to permit them to issue such certificates from Tajik Standart. However, this system creates a clear conflict of interest and potential source of capital flight and tax evasion that GOT should not only be aware of, but should seek to address. Obviously, the lower the certified quality of a shipment of goods, the lower the amount of export tax. The assessors are paid by the exporter to perform this function and it therefore creates a potential situation where the assessors could be placed under pressure to lower the qualities on the certificates. Of course, the exporter is able to avoid any losses from the lower quality certificate by either selling on private certificates, or re-certification in the port of destination (or they could effectively sell to themselves). From interviews undertaken, it does not appear that there is a system of monitoring of certificates at the points of export from Tajikistan. - 16 - 4.9 Bale weights The weights of the bales that are exported are also certified by the gins themselves, with no provision for spot weighing at the points of export. Given that the weight of exported cotton is also a factor in assessing the total value of the cotton export tax, this is a clear conflict of interest. All of the gins visited or individuals interviewed noted that average bale weights were in the region of 205 to 210kgs. However, rail bills that were examined indicated that the net weights of wagons containing 240 bales were in the region of 45 MT. This would imply an average bale weight of 188kgs, or approximately 10% less than had been reported. It should be noted that private gins operating in other FSU countries have increased their bale weights to 225 to 230kgs. The reason that they have done this is that it represents a significant saving on freight. V. Alternatives to the Investor System It is argued by many in Tajikistan that the current system, while not perfect, is the “better of two evils.” It is felt that, without the investor system, there will be no seasonal credit or input suppliers and that this will lead to a collapse of cotton growing (with a corresponding reduction in GOT’s tax revenues). However, this does not appear to be the case, as there is already an actively growing commercial credit market, with Todjirsodirot Bank and AgroInvest Bank already making loans to the cotton sector (approximately 40 million Somoni in 2004 season). It would also appear that there are a number of private rural financiers who work with farmers on an informal basis. The growing numbers of farms who are free from debt also appear to have begun to start financing their growing operations from their own funds. On the input side, there are a large number of private companies involved with the importation of commodities such as fertilizer and diesel. In fact, many of these companies are supplying the investors with their inputs on a supplier credit basis. They are raising their own finance for their trading operations (from their own sources, domestic/foreign banks and export supplier credits). There is nothing to suggest that these parties would not be prepared to work directly with farmers and, in fact, some of them already are. These companies are also selling inputs in the local markets for cash (at prices much cheaper than supplied through the investors). Farmers interviewed noted that inputs were readily available in the market place. There is also a very active private market for the supply of machinery and spare parts from various origins. This is being further supported by the provision by some of the commercial banks of basic leasing lines (e.g. Todjirsodirot Bank now have a pilot 3 million Somoni line and are due to receive a further line from the EBRD). While it is argued that this alternative system cannot operate due to a lack of collateral availability, it should be noted that the credit institutions and supplier creditors are managing their risks by taking a very active role in the monitoring of their clients. They generally check on their clients’ progress on a bi-monthly basis using their local loan officers and a team of agricultural specialists. As we are all aware, the actual provision of land as collateral is not a perfect risk management tool for lenders in any event, as even if they can seize land in case of default, their ability to sell it in the local area is very difficult (neighbors are not willing to buy the land). Therefore, the requirement for collateral tends to be a necessity more for provisioning requirements than actual risk management. 5.1 Potential solutions to current problems Although the cotton sector in Tajikistan has been theoretically privatized, there are various steps that can be taken by GOT to improve the current situation (listed below). GOT should not, however, be encouraged to intervene into private commercial affairs directly, nor should they contemplate becoming involved once again in the sector. The role of GOT is to create an environment that is conducive to competition, investment and development. - 17 - 5.1.1 Cotton pricing a) Price formula. The current formula needs to be altered to bring it more into line with current CIF to FOB discounts. The easiest way to do this would be to remove the so called 5% trade discount that is included in the formula. b) Set price. The formula is currently acting as a set price. This should be altered so that prices in excess of the formula can be achieved by sellers. Registration of prices in excess of the formula must be allowed. c) Seed cotton. As a large number of investor contracts are now concluded for delivery of seed cotton and that there is no real competition, a minimum indicative price for seed cotton should be established. Review of the investor contracts should be undertaken by TUGE to ensure that minimum prices are being paid at the time of delivery of the seed cotton. d) Other sales terms. The insistence on FOB contracts has to be removed to increase seller flexibility and potentially increase seller returns. In order to do this, TUGE should draw up a minimum price matrix providing for various delivery terms. e) Forward sales. It is clear that more sophisticated sellers may be able to increase their revenues by selling forward, at times when the market is higher than they expect it to be in the future (when the physical cotton will be available). GOT will have concerns about such contracting, as it may lead to capital flight through deliberate low forward selling. One way of minimizing the risk of this is to insist that forward sales can only be achieved through an open cotton auction carried out at TUGE. 5.1.2 Export tax a) FOB value. There is no logical justification for setting the export tax on an FOB value. Further, such a tax penalizes the sector in years when prices are lower and it can least afford to pay such high taxes. If GOT insists on maintaining the export tax, it should be based on an ex-works price (related to the price matrix). If a seller manages to sell at higher than this price or at reduced costs then that should be to their benefit. b) Date of fix. There appears to be a lot of confusion at the moment as to the date on which the tax should be calculated. A much better system should be the date of registration of the contract at TUGE. To avoid speculative registrations, the law should state that payment for the goods in question should be within five banking days of registration and shipment should be effected within 10 working days of registration. These time parameters would give both buyer and seller sufficient time to effect the transaction. 5.1.3 TUGE a) Auctions. TUGE is currently only used as a monitoring and licensing body. According to information received from TUGE, they do have the infrastructure to enable them to hold baled cotton auctions and have actually done so on a limited basis previously. There is clear value in the existence of an active auction system and GOT should enable producers and investors to access such a resource. The TUGE will need to be reviewed and amendments made for operative legislation to enable this to occur. b) Price monitoring. Given the inadequacies of the current investor system, TUGE must be empowered, where they find that input prices are in excess of the norms that they monitor, to actually deduct the value of the overpricing from the Akt Sverkhu. At the - 18 - moment, they are only able to reduce the amount of cotton that can be exported, which leaves the farm in a worse, not better position. 5.2 Hukumats While it is clear that current legislation prohibits hukumats from interfering in the crop and investor decision making process at the farm level, it is even clearer that this is not being adhered to. GOT has to make concerted efforts to improve this situation and to ensure good governance. Without such action the farming sector as a whole, let alone the cotton sector, will continue to suffer from limited growth and pernicious poverty levels. Total removal of the cotton production quota in name and fact would be a first step to alleviating this situation. 5.3 Cotton classification a) New standards. In order to benefit from more accurate classification of baled cotton and attract the correct premiums and discounts based on quality, it is necessary for Tajikistan to move away from the old Soviet grading system. Given that cotton is traded internationally on the basis of the USDA cotton standards, it is suggested that GOT should accept these standards as being applicable in Tajikistan. In the initial instance these can be applied through manual classification, but the introduction of HVI testing should be considered in the near future. b) A new certification organization. In cotton trading, as with many other commodities, the value of the quality certificate is dependent on the trade’s perception of the issuing organization. If the trade have no confidence in the professionalism or independence of the issuing authority, then they will be reticent to trade on the issued quality certificate and will continue to undertake their own physical inspections. Thus we come to the important distinction between an organization that is responsible for introducing and maintaining standards and one that is responsible for implementing them. Such a distinction is common international practice and is enshrined in the WTO provisioning for Codex Alimenatarius. It is therefore suggested that GOT, while it should maintain the role of Tajik Standard as the standards maintenance organization, the issuing of certificates should be licensed to other parties. Given the peculiarities of the Tajik situation, it is suggested that the best way to achieve this would be for GOT to create a joint venture with a recognised international quality controller, which would be the organization that would issue the actual quality certificates. This would be to the benefit of GOT, as they could now rely on the certificates as issued for the calculation of tax and for the trade who would now place a large degree of trust in the quality certificates (due to the involvement of the international partner). c) Weight certification. While bales are weighed in the gins and this is standard practice, the above organization should also be responsible for undertaking sample weighing of bale weights on a random basis at the points of export (for example on a 10% basis). In a situation where there are found to be weight discrepancies in random weighing in the order of 3% or higher, all bales should be weighed. This will ensure that any inaccuracies in reported bale weights will be detected and rectified, which will further increase the accuracy of the calculation of export tax. 5.4 Land a) Land certificates. Where land has already been subdivided from the original collective or state farm, land certificates should be immediately issued. A further concerted effort is required to subdivide any land that has not already been allocated to private farmers. This will increase farmer confidence and encourage them to undertake vital investments in their land holdings (such as drainage works). - 19 - b) Land pledged as collateral. As a matter of urgency, GOT needs to introduce legislation that will enable land certificates to be pledged as collateral in financing agreements. This will enable the current system of liens over cotton production to be removed and this will permit farmers to choose to who they will sell their cotton after picking. This will immediately introduce the concept of competition amongst ginners/seed cotton buyers. Given the large number of gins in the country and their relative density, farmers will have a choice of more than one partner. c) Removal of land use right. The current ability of hukumats to rescind land use certificates needs to be removed. The uncertainty of the system and the negative effect that this would have on collateral values of land will be debilitating to the financing sector and seriously impede development in the agricultural sector. 5.5 Certification As we have mentioned above, seve permissions are currently required before a party can export cotton. Not only is this a large number of permissions and expensive to obtain, but it involves a large amount of time to organize. The system of export registration needs to be streamlined and standardized in order to increase its efficiency. The advantage of this will be that a number of international traders who currently do not operate in the country (due to such difficulties) will become actively involved in Tajikistan, increasing competition and having a positive effect on prices. 5.6 Seed industry In order to encourage domestic development of the seed industry and enable the short term introduction of foreign varieties, a number of legislative steps need to be taken (covered in other studies). Of paramount importance is the necessity of protection of breeding rights and genetic material, without which foreign seed breeding organizations will not allow the import of their seed. Despite strong statements from MOA, it is felt that the efficient and effective development of the seed industry is dependent on the privatization of this sector. - 20 -