Report No. 12989-KG The Kyrgyz Republic Agricultural Sector Review (In Two Volumes) Volume I May 17, 1995 Agriculture, Industry and Finance Division Country Department III Europe and Central Asia Region -'IN ., ,T, X . --- CURRENCY EQUIVALENTS Until May 10, 1993 After May 10, 1993 Currency Unit = Ruble Currency Unit = Som Ruble = 100 kopecks 1 Som = 100 tiyns Period Average End of Period (Rubles or Som per US Dollar) 1992 Rubles Quarter I 102.4 100.0 Quarter II 94.6 100.0 Quarter III 177.7 254.4 Quarter IV 396.4 414.5 1993 Quarter I 580.1 684.0 Som Quarter III 4.1 4.3 Quarter III 5.6 6.5 Quarter IV 7.8 8.0 1994 Quarter I 10.1 11.7 Quarter IV 10.9 May 10 - June 30, 1993 WEIGHTS AND MEASURES Metric System GOVERNMENT FISCAL YEAR January I - December 31 ABBREVIATIONS AMPC Antimonopoly and Pricing Committee ERRA Enterprise Restructuring and Resolution Agency ESAF Extended Structural Adjustment Facility GDP Gross Domestic Product FSU Former Soviet Union IMF International Monetary Fund JSC Joint Stock Company MITMR Ministry of Industry, Trade and Material Resources NBK National Bank of Kyrgyzstan SOE State Owned Enterprise SMP Special Means of Payment SPF State Property Fund VAT Value-added Tax THE KYRGYZ REPUBLIC AGRICULTURAL SECTOR REVIEW TABLE OF CONTENTS EXECUTIVE SUMMARY ..................................... i MAIN REPORT ........................................... I Background and Recent Developments .......................... I The Inherited Agricultural Sector: Commodity Mix and.Famn Sructure ....... S Consumption and Food Security .... .......................... 6 The Status of Reform ................. 8 The Policy and Regulatory Environment: Pricing, Marketing and Foreign Trade ........................................... 11 Exchange Rate Policy ............. ...................... 14 Subsidies and Taxes . ................................... 14 Agricultural Finance .................................... 17 New Role and Structure of Government to Support Reform .... ........ 20 Land Reform and Restructuring of Farms ....................... 23 Privatization of Marketing and Services ........................ 29 Strategy for the Crop Sector ............................. 30 Irrigation and Water Policy ............................. 32 A Strategy for the Sheep and Wool Sector ........... ........... 33 Recommendations and Conclusions ........................... 37 LIST OF FIGURES AND TABLES Figure 1: Agriculture's Share of Total Exports, 1988-92. I Figure 2: Agricultural Output in Constant 1983 Prices. 2 Figure 3: Pasture Productivity in Selected Periods. 2 Figure 4: Meat Production and Processing, 1988-93 ......... ..,, 3 Figure 5: Agricultural Wages as a Share of Average Wages, 1985-93. 4 Table 1: Domestic Supply Agreements: Minimum Amounts of Agricultual Products to be Purchased for the State Needs for 1994 and Guaranteed Purchasing Prices (excluding VAT) . 9 EXECUTIVE SUMMARY 1. The Kyrgyz Republic is a mountainous country at the northern extremity of the Himalayan range. The population is predominantly (63%) rural, and per capita gross national product (GNP), estimated at $850 in 1993 and $610 in 1994, is lower than average for countries of the former Soviet Union. Kyrgyz agriculture is diverse, with intensive irrigated cropping in the low and level lands, and large areas of extensive grazing in the mountains. Primary agriculture employs approximately one-third of the labor force, and generates about one-third of GDP. Another 10% of the labor force is employed in industries processing food, fiber, and skins. Wool and woolen products, mutton, beef, fruits and vegetables, honey, tobacco, cotton, and silk are among the major products. 2. Agricultural output declined approximately 22 % between 1990 and 1993, with continued decline in 1994. The decline in the livestock sector is somewhat greater than in the crop sector, but both subsectors are experiencing difficulties. In the Kyrgyz Republic, the economic problems common to agriculture during the transitional period are compounded by a severe ecological imbalance inherited from the past. 3. Since 1990 Kyrgyz agriculture has been on a downward spiral of declining output, worsening productivity, retreat of farms from marketed transactions into self- sufficiency, falling earnings in money and kind, and a deteriorating natural resource base. The sector was pushed onto this trajectory by the very difficult conditions at the time of the break-up of the USSR, including the worsening in terms of trade, withdrawal of transfer payments, loss of markets, and monetary instability. The decline continued in 1993 when inconsistency in the reform program imposed additional problems for agriculture. The introduction of an ambitious program of macroeconomic stabilization in the summer of 1993 was not accompanied by structural reforms and sectoral policies to facilitate adjustment of agricultural production and marketing. Conditions for the granting of credit became more stringent and interest rates rose. Although rates were not positive when measured against inflation, agricultural borrowers were unable to take on commercial credit at these rates because agricultural producer prices remained subject to controls. 4. Price controls, compulsory marketing, export restrictions, and administrative interference in farm management reduced farm earnings and the ability of farms to finance operations from their own resources. Delays in payment for products already delivered in an inflationary environment further reduced real producer prices. The shift in credit policy exacerbated a financial crisis in agriculture that was already severe, but not fully evident under the prior (more lenient) credit policy. Banks were less willing to lend to farms and many farms voluntarily withdrew from credit markets as nominal interest rates exceeded 300% in fall of 1993. Farms turned away from commercial production and oriented instead toward food self-sufficiency for their employees. This trend is evident in the fall in marketed and processed output, which is greater than the fall in production. In late 1993 the macroeconomic program faltered under the weight of accumulating inter-enterprise arrears in all sectors and additional emission of credit, the latter in part to facilitate procurement of the fall crop. - 11 - 5. Early in 1994 new efforts were undertaken to put the macroeconomic program back on track, this time accompanied by a more vigorous program of sectoral adjustment. New components of the sectoral adjustment program introduced in early 1994 include a decree intended to revitalize the program of land reform and farm restructuring, a reduction in the amount of product that producers are compelled to deliver at administered prices, and removal of many restrictions on exports. These and additional efforts to strengthen the sectoral reform are important because little effective change in the regulatory and institutional environment of agriculture had been accomplished through the end of 1993. Prices 6. The price mechanism remains directed, although not formally administered. Some of the direction is accomplished by interference of local agricultural administrators in marketing decisions of agricultural producers. Local administrative interference in marketing decisions of agricultural producers should be discontinued. Controlled marketing margins at the retail level imposed on all products in July 1993 were removed in 1994. Agricultural prices were removed from those formally regulated by the Anti-Monopoly and Pricing Committee. By decree of January 24, 1994, producers of most products were given freedom to export without taxes or licenses after they had met deliveries for domestic supply agreements. Export barriers in the form of licenses and taxes remain for grain, hides, skins, live animals, and six nonagricultural commodities. License requirements and export taxes on all agricultural commodities should be removed so that producers have free access to external markets. Without this access, producers will not have earnings needed to finance recovery of production. The effect of the trade barriers on domestic producer prices can be seen in the grain sector. Since the Kyrgyz Republic is a net importer of grain, domestic producer prices should be higher than Kazakh border prices by the cost of transport. Instead, domestic Kyrgyz prices are reported to be ten to twenty percent below Kazakh border prices. Depressed producer prices retard recovery of production. 7. In order to enhance the competitiveness of pricing, producers should have access to more information about prices in different localities in the Kyrgyz Republic and in major markets abroad. Initially the government should provide market information through public extension activities of the Ministry of Agriculture. At a later date, the public and private sectors can be expected to complement each other in provision of market information services. Reforms in Marketing Policy and Institutions 8. Measures should be undertaken in several areas to increase competition in marketing. Until early 1994, producers remained subject to a number of different instruments of compulsory delivery. Under state orders (for wool, cotton, tobacco, and grain), producers were required to deliver to state or parastatal agencies at administered prices. State orders were replaced in March 1994 by domestic supply agreements, under which contractual arrangements replaced explicit compulsion. The contractual process is not competitive, however. Intended procurement under domestic supply agreements in 1994 - jjj - covered about 20% to 25% of production of grain, cotton, tobacco, seeds, livestock and poultry, and wool, with the exception of fermented tobacco, for which the share was higher. Even though a degree of compulsion remains in domestic supply agreements, actual deliveries in fulfillment of agreements are declining because the procurement agencies are unable to pay on time. Domestic supply agreements should be replaced by competitive tendering of bids to purchase on the state's account. The amount of product procured by the state should be limited to that for which the state can pay in a timely fashion. Privatization of organizations that dominate agricultural marketing should be pursued vigorously. 9. The remaining commercial functions under the Ministry of Industry, Trade and Material Resources (MITMR) should be corporatized. The distribution network of MITMR should be restructured, including restructuring of debt, to create independent units potentially capable of attracting commercial financing for marketing activities. The pending privatization of much of The Bread Products Enterprise should move ahead expeditiously. The functions of Kyrgyzdanazyk should be carefully reviewed to determine which should pass to the private sector. For example, bread supply to major cities is within the normal realm of activity of the private sector in market economies. A plan for privatization of Kyrgyz Tamak-Ash (marketing of processed food products), currently in process, is also a very welcome development. In the design of privatization of food processing, ample opportunity should be created for foreign participation through purchase of controlling shares where foreign interest is expressed. Experience in Eastern and Central Europe and other countries of the former Soviet Union has shown that foreign investment in food processing is largely dependent on majority foreign ownership of enterprises. 10. Input supply is still managed by the traditional monopolies for agricultural chemicals, machinery, and fuel. These are intended to function as financially independent state enterprises. They do not have juridical monopolies, but depressed demand for inputs has made entry of new private competitors unattractive. The units within Kyrgyz Selkhozkhimia (chemicals) that enforce health and safety standards for agricultural chemicals should remain in the public domain. Plans for privatizing the remaining activities of input supply for Selkhozkhimia and other input suppliers should be developed early in 1995 and implemented expeditiously. Experience elsewhere has shown that retention of the parastatal monopolies in input supply leads to progressively worsening finances of these organizations and continued problems of supply and distribution. Where these organizations were privatized and restructured early, as in Hungary, input supply was reestablished on a competitive basis rather quickly. Foreign Trade 11. Throughout 1993 important exports remained subject to licensing and taxation, and grain exports were banned. In addition, local officials had authority to restrict movement of products out of their jurisdictions, and to interpret terms of signed contracts. In early 1994, export licensing requirements were removed for most products. Exceptions in agriculture include grain, hides, skins, and live animals, all of which remain subject to export barriers that depress producer prices. The government has announced its intention to abolish clearing arrangements and bilateral trading agreements in 1995. The government has thus - iv - made substantial progress toward trade liberalization, but should continue liberalization by removing license requirements and export taxes for all agricultural products. Land Reform and Farm Restructuring 12. Land reform and reorganization of state and collective farms is proceeding within the general framework of the share system used in other countries of the former Soviet Union. All citizens have the right to use a garden plot. A smaller group of the citizenry, primarily the agricultural and rural population, have a right to receive both garden plots and a share of the land and other assets of state and collective farms. After receipt of land and asset shares, recipients can choose to leave their shares in collective management, or withdraw to form another kind of farm, one variant of which is the individual private farm. 13. A number of financially weak collectives were reorganized and some were liquidated in 1992, but the program did not attain the anticipated momentum in 1992 or 1993. Reasons for lagging implementation included lack of clarity and inconsistency in the design of the program, fragmentation of administrative responsibility at the national level and between the national and local levels, and the general perception that in a time of decline and demonetization of the agricultural economy, collectives offered members more security of material welfare than alternative smaller units. 14. The decree on land reform and farm reorganization of February 1994 addressed weakness in administration of implementation, and strengthened the legal framework within which land markets can develop. The Ministry of Agriculture and Food is charged with implementation, in conjunction with local authorities and rural committees. Although private ownership of land remains illegal, use rights will be secure for 49 years. Under the decree, us rights can be bought and sold, and can serve as collateral for lending. The rights of individuals to receive shares are affirmed, although the definition of the group of eligible participants still appears unclear. The size of the National Land Fund, intended to provide preference for ethnic Kyrgyz in the distribution of land, is reduced to 25% of arable land in the decree. 15. The program of land reform and farm restructuring requires further clarification. The program as it stands presents a number of questions that impede implementation and establishment of durable property rights. The Government has requested technical assistance to review the design of the program and procedures for implementation, and this assistance will be provided in 1995. Amendments to the program based on assessment of experience to date should be prepared in the first half of 1995 and formalized in fall of 1995 for implementation in 1996. A number of issues should be addressed in the review of the program. * The role of the National Land Fund should be clarified and its size should be further reduced. Procedures under which land will be designated for the land fund and reallocated from the fund should be clarified. Since markets in land rights can now develop legally, the need for administrative reallocation of land through the Fund is diminished. Management of the Fund should be consistent with development of the market in land use rights. * Constraints on the functioning of land markets should be removed, by constitutional amendment, if necessary. * Water rights and grazing rights at the farm level should be included in the design of the program of land reform and farm restructuring. Institutional arrangements for handling water rights and grazing rights are discussed elsewhere in the report. * The international agreements on reciprocal grazing rights with neighboring countries should be renegotiated with the objective of returning to Kyrgyz citizens pasture lands within the country's borders, particularly the summer pasture currently on long-term lease to neighboring countries. * Mechanisms should be designed to facilitate exit of producers from collective or state farms, either individually or in groups. This implies that the program should not stop with the distribution of shares, but should also determine procedures for allocating land and other assets to shareholders who wish to exit, either individually or by forming new business entities based on combined value of shares. * XProcedures for implementation and responsibility for implementation should be designed along with the new program. * A major effort at public education and pilot privatization should be undertaken. 16. The design of a stronger and implementable program will take approximately a year, and should be completed by autumn 1995. In the interim, state and collective farms should be freed from administrative oversight by local offices of the Ministry of Agriculture. This will give the farms greater authority to market their output advantageously. As the farms achieve full administrative autonomy, however, there is an increased danger that farm assets, such as herds and machinery, may be sold off in ways that are detrimental to the interests of the eventual recipients of shares. It is, therefore, desirable to accelerate design and announcement of the new program. In addition, executive boards of collective and state farms should approve and submit to the members or employees decisions on divestiture of assets prior to distribution of shares. There are likely, nonetheless, to be complaints that assets were improperly sold prior to formal reorganization of the farm. This is one of the many costs of the three-year delay in land reform and farm restructuring. Agricultural Finance 17. The agricultural financial system is under severe stress. The main agricultural lender, Agroprom Bank is technically insolvent, although it continues to operate. Agroprom - vi - Bank and other lenders hold large amounts of inherited farm debt, much of which cannot be repaid. Banks have continued to refinance the debt and to carry it on their books, rather than enforcing their legal claims and liquidating borrowers' assets. 18. Credit allocated to agriculture throughout 1993 was directed through special programs and highly subsidized. Credit subsidies were discontinued in 1994, and the volume of lending to primary agriculture contracted sharply. Within the total volume of short-term agricultural credit, a declining portion actually financed current production. An increasing proportion of total short-term bank credit to agriculture has gone to commodity procurement organizations and processors. Of the credit that went to farms, most was used to roll-over past debts at higher nominal interest rates without regard to the farm's ability to repay. Both supply of and demand for long-term credit for agricultural investment is virtually nonexistent due to conditions in the financial and production sectors. Loans that are made available through the credit auction carry maturities that are too short to cover the length of a crop production and marketing cycle. 19. Decisions regarding the future of Agroprombank and reform of agricultural lending institutions should be made within the context of the reform of the financial sector as a whole. The branch structure of Agroprombank is at present the only physical network of lenders in rural areas. This branch structure is likely to be needed in the future, but it is not yet clear in what organizational form it can be viable in the future. 20. Problems of agricultural finance will remain acute for some time. Until interest rates decline and the health of the banking sector improves, agriculture will continue to face high nominal interest rates and poor access to credit. Problems of agricultural credit can be most effectively addressed through sound macroeconomic policy and measurable progress on strengthening the banking system. In the short run, these efforts may need to be supplemented by special arrangements for credit to finance agricultural production and procurement. Several features should be incorporated if special programs are designed. 21. Interest rate subsidies should be avoided as much as possible, although special terms of loans may be needed (for example, nine-month loans instead of three months) to account for the duration of the product cycle in agriculture. Experience with subsidized credit programs elsewhere in the world has shown that they are in general poor instruments for meeting the needs of agricultural finance. Since the credit is subsidized, there is a tendency for it to be diverted to uses other than those for which it is intended. Some credit simply substitutes for borrowing that would have taken place in any case at commercial rates. Subsidized rates allow projects to show an acceptable financial return without a commensurate real economic return. Such projects are not the best use of scarce credit resources. For these reasons, subsidized credit programs should be phased out as price and marketing policies that discriminate against agriculture are removed. 22. New loans for production or procurement should be partitioned off from bad debt of the past, and loan applicants should be required to show cash earnings sufficient to repay the loans. New loans should be more strongly collateralized than in the past. The legal basis for seizure of a pledged asset should be reviewed to enhance collection on new loans that fall overdue. - vii - 23. Simple procedures for greater use of suppliers' credits should be designed, especially if new private firms become more active in distribution of agricultural inputs. Under suppliers' credit, the firm providing input supply also finances the producer's purchase of the input, and enforces repayment through collaterization, or threat to discontinue lending in the future. Use of suppliers' credit could provide a mechanism for separating bad debt of the past from current lending. The possibility of participating in programs of suppliers' credits should be presented as an option for private input suppliers that emerge through privatization of the large parastatals. At present, the parastatal input suppliers are so weak financially that they cannot participate fully in programs of suppliers' credits designed on terms similar to commercial financing in market economies. Smaller competitive firms specializing in marketing activities, however, could participate in such a program. 24. In order that farms can make prudent decisions regarding debt financing and apply successfully for loans under new conditions, farms will need advisory services to prepare business plans. This service should initially be provided by local extension agents through the Ministry of Agriculture. In time, a private sector selling advisory services can be expected to develop. The Livestock Sector 25. The Kyrgyz Republic is among the countries of the former Soviet Union that inherited a large livestock sector dependent in part on imported and underpriced concentrate feed. Consequently, the need for adjustment in this subsector is substantial, and a reduction in herd size is underway. Productivity of the livestock sector deteriorated in 1993, partly in response to inappropriate pricing and marketing policy, and partly because the herd reduction was distorted by halting implementation of land reform and farm restructuring. Livestock nutrition and animal health worsened. As collective and state farms faced difficulty in providing feed for their animals, sheep and cows were transferred to the household sector without an increase in household lands or any specification of grazing rights on the land traditionally used for household flocks. The common grazing land around villages is even more overgrazed than in the past. The transfer of animals from the collective herds to the household sector serves in lieu of wages on farms that lack liquidity and are in arrears to their workers. 26. Severe degradation of pasture land and consequent problems of soil erosion are the legacy of excessive build-up of the herd during the Soviet period. The Kyrgyz sheep population has declined from 10.2 million in 1985 to approximately 8.8 million in late 1993. According to estimates of the mission, a herd of six million sheep structured to relieve acute pressure on winter pasture could be managed economically and would allow substantial recovery of pasture productivity. A smaller herd better fed and managed would yield wool of higher quality and meat of higher value. 27. The excessive inventory of sheep and cattle represents a significant internal reserve that could in part finance restructuring of Kyrgyz agriculture. Traders from Middle Eastern markets have expressed interest in Kyrgyz sheep meat, but export barriers in place throughout 1993 made transactions very costly. If the meat does not move onto export - viii - markets, the herd reduction will continue as in 1993, with animals transferred to the household sector, where they lose weight and health until they are slaughtered and consumed for a fraction of their value. If, on the contrary, the meat is exported, a flock reduction of 2.4 million sheep over three years and disposal of 95,000 cattle to export markets suggests potential revenues of $17 million in 1994, $34 million in 1995, and $29 million in 1996. Purchase of mobile modular slaughterhouses that process meat according to export standards would be necessary, since Kyrgyz facilities do not meet export standards. These have estimated total cost f.o.b. Europe of $2 million for three units. Meat processed in current Kyrgyz processing plants does not meet health standards of European and North American markets. The export tax on live animals is intended to encourage capacity utilization in the processing industry. Domestic processing in currently operating plants, however, restricts markets for exported meat. The export tax on live animals should be removed in order to facilitate exports of livestock products in all forms that can be marketed. 28. The necessary reduction in herd size should take place through decisions of producers and traders, and not through a special program of government. As grain prices rise, producers will have strong incentives to reduce herd size. The transfer of animals to the household sector cannot at present be prevented administratively, although restricted grazing rights on common village fields can be imposed. The government can facilitate the herd draw down by intervening speedily to remove local trade barriers that may appear periodically, and by publishing information on prices in world and regional markets. 29. A number of additional technical interventions will be needed to enhance the performance of the livestock sector. These include attention to eradication of brucellosis, improved advisory services for smallholders in the private and household sectors, continued support for a core program of agricultural research, and establishment of an independent wool testing laboratory. The Crop Sector and Water Policy 30. Yields are falling in the crop sector because financing for the purchase of inputs is unavailable or perceived to be expensive, and prevailing relative prices make purchase of yield-enhancing inputs unprofitable. In addition, the increased use of barter, payment in kind, and desires for food self-sufficiency lead to changes in the cropping mix that are not necessarily consistent with the productive assets of the farms. Although there are technical questions that should be resolved and could increase yields, the main problems of the crop sector at present derive from distortions in pricing, marketing, trade, and finance. 31. Irrigation is a critical component of the capital stock serving the crop sector, and adequate maintenance of the irrigation system should be given high priority. At present the national irrigation system delivers water to the farm gate, and farms are expected to maintain the system within their territory. New institutional arrangements must be introduced at the farm level to manage the distribution of water within the former collective or state farm, and to maintain the infrastructure. A common solution used in other countries is the water users' association, in which members distribute water licenses among themselves and pay fees to maintain the irrigation equipment and canals. These associations should be - lx - formed at the time of farm reorganization so that those who exercise their right to withdraw from the collective will retain access to water and share responsibility for maintenance of irrigation. Fees for water use should be high enough to cover most of the costs of operating and maintaining the system. At present fees are not collected systematically, and their level is not high enough to cover costs of operation and maintenance. 32. Because changes in the cropping patterns are not yet clear and future demand for water is not known, there should be a cautious approach to new investments in irrigation until needs become clearer. 33. Water quality is an important issue for the Kyrgyz Republic because of the country's relatively abundant water resources and geographic position high in the water-shed. Degradation of pasture land has contributed to soil erosion with a resulting reduction in water quality. Rehabilitation of pasture land will thus be an important component of an environmental program to preserve soil and water quality. New wool scouring operations that may develop should be held to high standards of effluent control. 34. The Kyrgyz Republic's share of water resources originating within the country is governed by interstate agreements involving the five Central Asian states. These agreements should be reviewed within the context of the full range of regional interstate agreements to assure that the Kyrgyz Republic is achieving maximum benefit from its valuable water. Consumption and Food Security 35. With the reduction in agricultural output and fall in real wages since 1990, concern about food security has grown. The question has been raised whether it is appropriate for the Kyrgyz Republic to attempt to ensure food security by introducing special incentives for domestic production of wheat. Although domestic self-sufficiency in staple foods has been sought by a number of countries in the world, these policies have in general been costly for the budget and for society. Maintenance of financial reserves on the part of the state with which to purchase grain for vulnerable consumers is less costly over the long run than support for domestic production at prices above border levels. Removal of policies that currently discriminate against the grain sector, such as the export tax, would improve incentives for production and, therefore, enhance food security. 36. Simply allowing domestic wheat prices to rise to border prices would provide incentive for wheat production and reduce wasteful use. In most years the Kyrgyz Republic is an importer of wheat for food, although total production of grain exceeds food needs. The quantity of grain needed for human consumption is between 770,000 mt and 800,000 mt. Domestic production of grain has ranged between 1.3 million mt-1.8 million mt, of which between .4-.8 million mt are wheat. Thus in most years the Kyrgyz Republic imports wheat for food as well as feed grain, although the aggregate production of grain exceeds food needs. x 37. The diet is on average adequate. At 35-40 kg of meat per capita annually, meat consumption is higher than in many countries with comparable incomes, reflecting the policies of the past and traditional prominence of livestock in the culture. Meat consumption is likely to continue to fall somewhat, reducing some derived demand for grain. Costs of production on Kyrgyz irrigated wheat fields are likely to be higher than in the extensive steppes of neighboring Kazakhstan. Adjustments in production and utilization of grain in the countries throughout the former Soviet Union are resulting in reduced demand within the region. It is thus likely that Kazakhstan will be a low-cost supplier of wheat for the Kyrgyz Republic, and the irrigated and relatively good soil of the Kyrgyz lowlands can be used for higher-value crops. An appropriate approach to assuring food security would thus consist of the following measures: maintaining open borders with Kazakhstan, allowing domestic prices to rise to border levels, removing the export tax on grain (so that domestic prices will not be depressed), and liberalizing marketing in grain, flour, and bread. 38. With these measures the aggregate availability of wheat is likely to be sufficient, although bread prices will be higher than they were under the past combination of state monopoly, subsidies, and restricted marketing. Access to flour for poor people and people in remote regions is likely to present more severe problems of food security than will the adequacy of aggregate supply. Programs of assistance distributing flour to the needy and to remote villages should be considered as part of a program to alleviate the hardships of poverty. The Role of Government 39. Implementation of the strategy for recovery demands a governmental role fundamentally different from that of the past. The change in the function of the government necessitates change in the structure of the Ministry of Agriculture and Food. Both the diminished role of the government in a market economy and the fiscal constraints of the current period suggest a smaller Ministry focused on the tasks of the public sector. These include analysis of policy, implementation of reform, dissemination of information, support for education, research and extension and enforcement of standards. A proposed ministerial structure is presented in Chapter 1 of the report. 40. The Ministry of Agriculture and Food should take the lead in presenting the problems of the sector, and seeking solutions within the general framework of the economy- wide reform program. This requires a breadth of vision that transcends the narrower task of sectoral administration that is traditionally the mandate of the ministry. The ministry should become more active in public education and outreach to advise participants in the agricultural reform regarding their new rights and risks, and how to manage them. The Ministry is asked to undertake these new functions at a time when its own budget is under pressure, experienced staff are leaving, and demands on its analytical and administrative capacity are growing. External assistance to the Ministry during this critical period will be very important. - xi - Agricultural Extension and Research 41. Extension and agricultural research will require particular attention. The research capacity is declining, as funding collapses and many trained scientists find alternative employment. A core program of agricultural research should be identified and put on solid funding. Research activities that are potentially marketable should be privatized to make room in the budget for core research. Research links with regional and national centers in the former Soviet Union and world-wide should be maintained for the core program. 42. Agricultural extension should be redesigned. Technical advice is still provided by the trained specialists in the state and collective farms. Some of the technical services can be privatized during farm restructuring, such as veterinary services and machinery repair. Others, primarily economic and financial advisory services, should be offered by the government initially, and training to design materials and approaches will be necessary. Private advisory firms will emerge later. One early focus of extension work should be preparation of farm business plans. Extension work in animal health should seek out managers of flocks in the private and household sectors, since the managerial level is low enough to pose health hazards for the animal and human populations. Recommendations and Conclusions 43. A number of measures should be given priority in the short run to facilitate agricultural recovery. These measures fall into the general categories of regulatory reform, structural reform, and investment. 44. Regulatory Reform: Domestic supply agreements remain in effect, and should be replaced by the unrestricted freedom to market and export goods. If the state chooses to procure agricultural commodities, it should obtain full financing for the purchases, and designate a commercial agent or state enterprise to undertake competitive bidding on its behalf. Import licensing should be required only for health and safety reasons, such as for agricultural chemicals. The export taxes on wheat, skins, and live animals should be removed. Imports of food, fiber, and agricultural inputs should be without tariffs, or should have low uniform tariffs so that domestic processing industries can grow and modernize. 45. Structural Reform: The program of land reform and farm restructuring should be thoroughly reviewed and revised in 1995, and vigorously implemented thereafter. Definition of eligibility to participate in the land reform should be clarified early. Water rights and grazing rights should be specified during the process of land reform and farm restructuring. The Ministry of Agriculture and Food should provide greater leadership in implementing land reform and farm restructuring, in partnership with local committees on which participants are represented. A massive program of public information should be launched. Privatization of food processing and distribution should continue. Privatization should include the parastatal monopolies that provide agricultural inputs, as well as the conglomerates in marketing. - xii - 46. Finance: Credit subsidies should be phased out as deregulation of pricing and marketing is implemented. Loans should be collateralized by farm production using market prices, and loan applicants should present a business plan demonstrating cash flow adequate to repay the loan. A decision regarding the future of Agroprom Bank (that is, whether to restructure the existing bank or form new institutions on its branch foundation) should be taken in 1994. 47. Water Policy: Water fees should finance most of the operating costs of the irrigation system, and water users' associations should be established as part of the farm reorganization. 48. The Role of Government: Within the Ministry of Agriculture and Food. a shift in emphasis and personnel from traditional administrative management of production to policy analysis, implementation of reform, and provision of technical and economic information to producers would better serve the sector under current budgetary constraints. The functions of local governmental officials should be redefined to focus on provision of information and explicitly to preclude administrative interference in production or marketing. Farms should be removed from the administrative jurisdiction of local agricultural officials. 49. Investment: Key public investments in animal health, market information, and business management for producers will improve productivity, export prospects, and public health. Private investments are also needed in production and processing. In order to attract private investment, privatization of farms and processing facilities should accelerate. 50. Policy recommendations are presented in matrix form below. In addition, a number of specific technical recommendations for the crop and livestock sectors are presented in the technical annexes. - xiii - Summary of Recommended Policy Reforms OBJECTIVE POLICY MEASURES 1. Provide appropriate incentives a Eliminate domestic supply agreements. for producers. In the Kyrgyz * Eliminate licensing requirements and export tax on wheat, case, this will improve hides and skins, and live animals. sectoral profitability. * Prohibit interference in interprovincial trade in agricultural products. 2. Improve incentives for good * Review and modify program of land reform and farm management and investment restructuring and implement program. * Privatize (with prior restructuring) the parastatal monopolies that provide agricultural inputs, as well as the conglomerates in marketing. 3. Improve financial services for * Phase out credit subsidies. agriculture * Collateralize loans for farm production using market prices. * Require business plans from loan applicants. Plans should demonstrate cash flow adequate to repay the loan. * Decide on the future of Agroprom Bank. 4. Secure continued operation of * Finance most of the operating costs of the irrigation system irrigation system from water fees. * Establish water users' associations as part of farm reorganization. 5. Enhance the positive * Reorganize the Ministry of Agriculture and Food to contribution of Government emphasize implementation of reform and provision of technical and economic information. * Eliminate departments devoted to management of production and processing. * Redefine the functions of local governmental officials to focus on provision of information and explicitly to preclude administrative interference in production or marketing. * Remove farms from the administrative jurisdiction of local agricultural officials. 6. Improve support services * Review portfolio of agricultural research eliminating some activities and strengthening support for others * Provide advisory services for farm finance and production, through improved extension service or other means. * Improve distribution of market information. THE KYRGYZ REPUBLIC AGRICULTURAL SECTOR REVIEW MAIN REPORT Background and Recent Developments 1. The Kyrgyz Republic is a mountainous country at the northern extremity of the Himalayan range. At $850 in 1993 and $610 in 1994, per capita GNP is lower than average for the countries of the former Soviet Union. Approximately 63 percent of the population lives in rural areas. One third of the labor force is employed directly in primary agriculture, and an additional 10 percent of employees work in industries processing fiber, food, and agricultural by-products. Primary agriculture contributes approximately one-third of gross national product, and the sector's contribution is augmented by value added in the processing industries. 2. The Kyrgyz Republic is known within the former Soviet Union as a supplier of high- quality yarn and woolen products, cotton, silk, tobacco, fruits and vegetables, honey, mutton, and beef. In 1990, about half of the total value of exports come from the agricultural sector, including processed food and fiber. Primary agriculture was responsible for 2.8 percent of exports in 1990, processed food for 20.1 percent, and light industry (much of which is fiber) for 29 percent (Figure 1). In 1992 agricultural exports declined to 1.6 percent of total exports. Processed food declined to only 7.1 percent of exports, and light industry to 24.1 percent. 3. Agricultural output declined approximately 20 percent between 1990 and F 1 Agr rlt rre -,f 1993. (Figure 2) Aggregate reported gross agricultural output fell 10 percent in 1991, 5 percent in 1992, and 8 percent in 1993. 4. The decline in the livestock sector is somewhat greater than that in the 4 _ crop sector, but both are experiencing difficulties. Output of the livestock sector declined 6 percent in 1991, 9 percent in 1992, and is estimated to have fallen 10 on percent in 1993. Animal numbers and productivity per animal both fell in 1993. In the crop sector, output fell 17 percent in 1991, grew 1 percent in 1992, and is 19R9 909 1ysr I 91 1997 estimated to have fallen 3 percent in 1993. Area under grain increased in 1993 by AJ, - I .-NF-ocq,1 d ht nd,St,v about 8 percent, but yields fell by about 9 __.r.-_ IMr - 2 - percent, so that production was roughly stable. Area under sugar beets roughly Figure 2 Agricultural Output in Constant 1983 Prices doubled in 1993, and output increased by 63 percent. Cotton production fell 3, 500 Mi( le- somewhat, as did that of potatoes. Production of fruits, vegetables, and grapes 3,000 - _______ declined by one-third to one-half. Tobacco 2,500 area and yields were up, and production increased by about 13 percent, but remained 2,000 below the levels of the late 1980s. t,500 5. The decline in the t,OO agricultural sector is relatively modest 500 compared with the decline in the industrial sector, which registered no change in 1991, t1987 198 1989 1990 1991 1992 followed by a 27 percent decline in 1992, bear and an estimated 27 percent decline for ELlvestockCrOS 1993. Nor is the agricultural decline in the Kyrgyz Republic to date as severe as in some other countries of the former Soviet Union. The aggregate figures, however, should not be interpreted to indicate relative stability of Kyrgyz agriculture. On the contrary, a number of disturbing developments suggest that agricultural performance may deteriorate markedly in 1994 and thereafter unless remedial measures are undertaken. 6. As of 1994, the Kyrgyz agricultural economy appears to be on a downward spiral of declining output, worsening productivity, retreat from commercial production into self-sufficiency, falling earnings in kind and money, and a deteriorating natural resource base. The sector entered this trajectory at the time of the break-up of the U.S.S.R., which brought worsening in the terms of trade, withdrawal of transfer payments, loss of markets, and monetary instability. The sector has remained on the downward spiral because needed sectoral reforms have been delayed. 7. Throughout 1993, Kyrgyz Pt <,:lct.vity 0 S0lctF0 agriculture functioned in a policy environment that severely depressed ?O- earnings through marketing quotas, - administered prices, and trade restrictions. In addition, reforms in land tenure, farm -I organization, privatization of key services, -- _ _ and the financial system had not made substantial progress by the end of 1993. Local administrators at the province and 219 _ district levels retained authority to intervene I _ _ _ _ in economic activity within their geographic jurisdictions, and their activities in pricing, n 18 199085 388-91 marketing, and enterprise restructuring were rear Iv aver reported to impede implementation of national reforms and emergence of more integrated markets. 8. In addition to the economic problems of the sector, the pastures that are the foundation of the Kyrgyz livestock industry are degrading rapidly, largely in response to overgrazing as feed from other sources becomes more scarce (Figure 3). Pasture degradation is contributing to soil erosion. Livestock nutrition and animal health are worsening, and productivity is consequently likely to decline. As collective and state farms face difficulty providing feed for their animals, sheep and cows are transferred to the household sector without specification of limits on grazing rights on common pastures. The increased number of animals in the household sector is a symptom of delayed adjustment and partial privatization, and it puts additional stress on village pasture resources already rapidly degrading. 9. The four problems outlined above (inappropriate policies and regulations, interventions on the part of local agricultural officials, slow structural reforms, and a worsening ecological situation) combine to impede recovery. In addition, producers are not paid upon delivery of output, and inflation reduces the real value of payment when it is finally received. In response, many farms are turning away from commercial production and instead distributing a larger proportion of output among their employees. This trend is evident in the fall in marketed and processed output (Figure 4), which is much greater than the fall in primary agricultural production. 10. The combination of price controls and compulsory marketing F gre 4 Meat F'rc.dL'Ct ,n nnd Prccess ng, 1988-93 throughout 1993 appears to have resulted in implicit taxation of agriculture, and transfer 1.000 tos 300 of income to other sectors. It is difficult to quantify the magnitude of the transfer 20 - -/ because data on producer prices received are imprecise. Furthermore, producer 200 - _.________ arrears in payment for inputs, taxes and credit partially offset implicit sectoral taxation. The symptoms of net discrimination of agriculture, however, are apparent. These include low farm earnings, - -_____________-F - lack of liquidity, and falling farm wages relative to non-farm wages. The financial 1998 1909 1990 1991 1992 1993 1/ deterioration at the farm level is greater Yea, than the fall in production, again suggesting -Poduced +-Processed a policy environrent that discriminates Source Goskomtdt against agriculture, primarily through de IJany-9epterber facto price controls and constraints on marketing. 11. The relative wage in agriculture has fallen since 1990, contemporaneous with a decline in economy-wide average real wages in 1993 to an estimated one-third of their val'ue in 1990. In 1988 agricultural wages were approximately 90 percent of average wages for the economy, and 75 percent of industrial wages. By August 1993, agricultural wages - 4 - had fallen to 53 percent of average wages for the economy, and 34 percent of industrial wages. 12. Agricultural employees have always supplemented money wages with . '" ,-- , earnings in kind and sales from household production. The dramatic decline in real ne eOt sectoral wages (Figure 5) implies that 1 distribution in kind within the collective units must have increased in importance, - __ and observations in the field corroborate this conjecture. Even including distributions in kind, however, real earnings of agricultural employees appear to have 4_ deteriorated relative to those in other sectors. The steep decline in industrial production and absence of widespread open unemployment would be expected to lead to erosion of industrial wages relative to 1987 9 1931 1993 agriculture, but this has not happened. Agricultural wages are extremely low at present because of arrears in payments to farms, residual trade barriers, and implicit 1' Ax/gust 1993 taxation of the sector. 13. Producers do not have the cash or access to financing to purchase inputs for 1994 at the same level as in 1993, and yields in the crop sector can be expected to fall in the current season. Early indications suggest that use of purchased inputs, including fertilizer, fuel, and high-quality seed is lower in 1994 than in 1993. 14. The decline in agriculture has a social as well as economic dimension. Data available for the first half of 1993 indicate that the net flow of migrants within the Kyrgyz Republic is away from rural areas and to cities. Although the net flow is out, there is still substantial movement into rural areas. Over half of the migrants into rural areas, however, went to Chui oblast', a more urbanized province among the rural areas. The data therefore suggest that the economic decline of agriculture is associated with population flows away from remote rural areas. There is great regional disparity in both the incidence of poverty and the delivery of assistance to the needy. The combination of agricultural decline and local differences in public assistance to the needy appear to be causing population flows out of poor rural areas. Migrants at present are responding to inter-sectoral distortions and disparities in the programs of assistance to the needy, rather than to more enduring changes in economic opportunities. The internal migration thus is likely to carry high social costs, as well as personal costs for the migrants. Measures to reduce migration out of remote rural areas should include reduction in regional disparities in assistance for the needy, and improved opportunities for producers of mutton and wool to sell on international markets for international prices. In addition, privatization of small trucks should accelerate so that mobile shops can supply remote areas with basic consumer goods. -5- The Inherited Agricultural Sector: Commodity Mix and Farm Structure 15. Commodity Mix.- Livestock products contribute about 60 percent of the gross value of agricultural output, and the crop sector contributes about 40 percent, when the aggregation is done in constant 1983 prices. Using more appropriate current prices instead of the constant accounting prices, the relative share of the crop sector increases appreciably. For example, if the value of 1992 gross output is calculated with 1983 constant prices, livestock products account for 64 percent of the sectoral total. If the same physical quantities are valued at current prices, the share of livestock drops to 43 percent. Crops now contribute somewhat more than half the value of output at current prices. 16. Economically important crops include tobacco, grain, vegetables, cotton, fruit, and alfalfa. Sugar beet was important in the past, but poor agronomic management resulted in widespread disease and declining area. Area is now expanding again. Winter wheat is the dominant grain crop, covering just over a third of grain area in 1992, and its area is also expanding. Spring barley is planted on about a third of the grain area. The remainder of grain area is planted with winter barley, spring wheat, and maize. Approximately half of the grain area is planted in the fall, as winter wheat and barley, and half in spring. 17. Because of the relatively small amount of arable land and because much of the arable is irrigated, Kyrgyz annual crops and cultivated grasses are managed intensively and should show high yields. Grain yields in the Kyrgyz Republic were between 2.6 and 3.0 tons per hectare in the late 1980s. These yields were higher than the average for the USSR, reflecting the higher proportion of winter grains and the prevalence of irrigation. In 1993 reported yields were 2.6 tons per hectare. Under growing conditions in The Kyrgyz Republic with economically justifiable use of high quality seed, fertilizer, and plant protection agents, grain yields could be increased substantially. At present yields are depressed by difficulties financing input purchases and by depressed prices for outputs. Higher yields can be expected to be among the benefits of improved financing and more liberal opportunities to market output. The Kyrgyz Republic is not a major cotton producer within the Soviet Union and, except for its prominence in bilateral trading agreements, cotton is of relatively less economic importance than other crops. Kyrgyz cotton yields were traditionally about average for thle Central Asian region. 18. Livestock production in the Kyrgyz Republic grew throughout the Soviet period under relentless pressure to increase herd size. Between 1960 and 1987 the number of cattle increased by over 50 percent, the number sheep and goats by 66 percent, pigs by 100 percent, horses by 25 percent, and poultry roughly by 300 percent. Along with the increase in animal numbers came an increased reliance on imported grain to feed them. The total feed requirement expressed in feed units (equivalent to a ton of oats) quadrupled between 1960 and 1987, and concentrates were an increasing proportion of feed. Feeding of concentrates, largely grain, increased six fold. Feed from pasture declined in absolute quantity by over one-half, reflecting the reduced yield on overgrazed pasture, and some conversion of pasture to cultivated land. In 1987, at the peak of the livestock herd and of feed consumption, the amount of grain used for feed was approximately twice that used for food. - 6 - 19. The Kyrgyz Republic is among the countries of the former Soviet Union that developed an export livestock industry dependent on imported and underpriced feed. Before the changes that began in 1990, the Kyrgyz Republic imported approximately 1 million tons of grain, divided almost equally between wheat and coarse grains, depending on domestic production. Domestic production of grain ranged from about 1.8 million tons in 1987 to about 1.6 million tons thereafter. Food needs have been roughly constant at 800,000 tons, 700,000 tons of which are wheat. Imports supplemented domestic supply of foodgrain, but the growth in imports came from demand for foodgrain. About 1.6 million tons of wheat and coarse grains were fed to animals until the decline of the past few years. By 1993 the amount of grain fed to animals had fallen to an estimated 700,000 tons. 20. Farm Structure: Agricultural production in the Kyrgyz Republic traditionally took place on collective farms, state farms, and in the household sector. There were 195 collective farms and 275 state farms in 1991. State farms tended to be somewhat smaller than collective farms, at 2,300 hectares of arable land, compared to 3,000 hectares on the latter. Average herd size on state farms was also smaller, at 16,000 sheep and goats and 1,400 cattle, compared with 22,000 sheep and goats and 1,800 cattle on the collectives. Despite a somewhat smaller size, state farms reported average capital assets exceeding those of collectives by about 50 percent. In addition to arable land, both state and collective farms had grazing rights on identified tracts of pasture to which the animals were moved for summer grazing. Prior to 1990, the household sector owned about one-third of the cattle, approximately one-fifth of the sheep and goats, about half the poultry, and one-quarter of the horses. The household sector held only 4 percent of arable land, but household production provided a high proportion of marketed fruits and vegetables. 21. Collective and state farms functioned much as they did elsewhere in the former Soviet Union. The traditional farms were also the units that managed irrigation at the farm level and were responsible for maintaining pasture lands. The irrigation system delivered water to the farm gate, and farms allocated it and maintained systems within the farm's territory. Farms were assigned mountain pasture lands within designated boundaries. Although individuals were not assigned summer pasture, household animals summered on the pastures of the large farms. Consumption and Food Security 22. There are two sources of information about average levels of food consumption in the country. Aggregate data on production, trade, and domestic utilization are used to calculate per capita domestic disappearance of key foods. These are shown in Statistical Annex Table 1.7. A household budget survey of 2,000 families was conducted annually in the Soviet period, and data are shown in Statistical Annex Table 1.7a. These sources differ in detail, but offer a consistent qualitative view of the Kyrgyz diet. 23. Meat consumption is probably in the range of 35 kilograms to 40 kilograms per capita. This is somewhat higher than in many other countries with per capita incomes as low as the Kyrgyz Republic. Meat consumption is likely to continue to fall as consumption adjusts to new prices and income levels. Reduced meat consumption on average would not bring nutritional deprivation. Concern about food security should not therefore lead to barriers to export of meat. 24. Consumption of bread and grain products has been on the order of 130 kilograms of flour equivalent per capita, and has declined a few kilograms since 1990. The decline probably reflects some reduction in human consumption, as well as lower waste and less diversion of bread to livestock feed. The quantity of grain needed for human consumption can be expected to remain approximately constant at 770,000 tons to 800,000 tons (about 700,000 tons of which is wheat). The grain balance is shown in Statistical Annex Table 1.6. 25. Kyrgyz production of wheat in 1993 was about 800,000 tons. Wheat production has varied over recent years from a low of 430,000 tons in 1991 to the high reached in 1993, when area under wheat expanded. Aggregate production of grain is more than adequate to cover food needs, but production of wheat in recent years has in general been less than consumption. In the past two years imports of food wheat have exceeded those of coarse grains, and much of the imported wheat has been donated under humanitarian assistance. 26. Neighboring Kazakhstan is a major exporter of milling quality wheat, and costs of production on the steppes are lower than in the more intensively farmed wheat fields of the Kyrgyz Republic under current yields. As grain prices in Russia rise to world levels and Russian grain production increases, the exportable surplus available to the Kyrgyz Republic at reasonable prices from Kazakhstan will increase. At present, export barriers on the Kazakh side (e.g., licensing requirements) constrain free trade in grain across the border. 27. With a net grain exporter as a neighbor, there is little economic justification for special programs or policies in the Kyrgyz Republic to promote self-sufficiency in wheat at high cost. The most effective policy to promote wheat production is one of open borders, so that domestic wheat producers and consumers face regional prices. At present, wheat exports from the Kazakh side are licensed, and from the Kyrgyz side exports are taxed at 30 percent. The effect of these two policies is to impede trade and reduce producer incentives in both countries. Producer prices for wheat in the Kyrgyz Republic (class 3 soft) at harvest were 348 som per ton in 1993 ($58) and 830 som per ton ($83) in 1994. Imports from neighboring Kazakhstan in 1993 cost $85-90 per ton. The farm level price in the US for No. 2 soft red winter wheat, which may be somewhat superior in quality to No. 3 soft Kyrgyz wheat, was about $1 10 in early 1994. 28. Discussion of food security should emphasize free trade and improved distribution within the country, rather than special programs to stimulate production. Physical disruption of delivery in remote rural areas poses a genuine threat to food security. Sixty-three percent of the population of the Kyrgyz Republic is rural, and a large share of rural bread supply has traditionally flowed through the consumer cooperatives. The consumer cooperative is currently under financial stress, and it is not likely to be able to continue to deliver bread and flour to outlying areas. A program of financial and organizational restructuring should be designed for the consumer cooperative and implemented in 1995 and 1996. In addition, privatization of small scale transport, such as trucks held by state enterprises in financial distress, should be accelerated, so that private - 8 - mobile shops selling basic necessities in remote areas can compete with the consumer cooperative, and replace functions in villages where cooperative stores close. The Status of Reform 29. After the country attained independence in the fall of 1991, the government of the Kyrgyz Republic began to formulate and implement a program of economic reform. In 1992 a number of changes in the legal framework to facilitate structural change were prepared. Early in 1992 most prices were formally decontrolled. Under the new price regime, however, price mediation committees under the Pricing and Anti-Monopoly Committee at the national, province, and district levels were given authority to intervene in price determination. 30. In May 1993 the national currency, the som, was introduced. Limitations on profits and marketing margins on consumer goods were introduced simultaneously. The combination of controlled marketing margins, recommended procurement prices, and close oversight of pricing by the Anti-Monopoly Committee resulted in continuation of de facto price controls throughout 1993. 31. A number of changes in pricing and marketing policy were introduced in early 1994, but implementation has been partial. Procurement by the state is no longer undertaken through state orders, but instead through domestic supply agreements. Domestic supply agreements differ from state orders in the degree of compulsion and scope for negotiation. Procurement prices announced in January 1994, are expected to be adjusted upward as necessary to facilitate purchase. Because the state procurement organizations are in poor financial condition and have a history of late payment, producers are increasingly selling to private firms or through barter arrangements. Proposed quantities to be procured under domestic supply agreements for 1994 are contained in the government resolution "On stimulation of production and sales of agricultural products in 1994," adopted in January 1994. These quantities are shown in Table 1 (next page). According to the resolution, agricultural products in excess of those procured under domestic supply agreements can be sold internally or exported without licenses. Since few enterprises have financing for purchase of commodities at state procurement prices, sales throughout 1994 were reported at cash prices below procurement prices. 32. Throughout 1993, agriculture continued to receive directed credit at preferential rates, although most credit was used to roll over past debt and reduce arrears, rather than to maintain current production. Agroprom Bank is the primary agricultural lender, and is technically insolvent, although it continues to function. A credit auction functioned for part of 1993. With producer prices controlled at low levels, there was little agricultural demand for loans for primary production at the short terms and high nominal rates available through the auction. 33. Land reform and farm restructuring were initiated by decree in 1991. Under the program, collective and state farms can reorganize through the share system, and members and employees can withdraw land and asset shares if they so choose. Some progress was made in 1992, but the program was suspended in early 1993. Of the 480 9- collective and state farms at the start of the process, 165 had been reorganized by August 1993. Many cases of restructuring are largely cosmetic, and the distribution of shares to members and employees has brought little change in the management of the farm. Between 16,000 and 21,000 private farms have been formed. Many of these are in associations of private farms, and the extent to which the association departs from patterns of collective production and management of the past is not clear. Table 1: Domestic Supply Agreements: Minimum Amounts of Agricultural Products to be Purchased for the State Needs for 1994 and Guaranteed Purchasing Prices (excluding VAT) Price per ton Amount 1994 1995 Est. % % of Ref. Purchases 1993 World Commodity '000 tons Output in Som in US$* Price in Som in US$* Grain - total 312.0 20 of which: - soft wheat 3rd sort 212.7 25 830 83 83 348 58 - seeds of grain/cereal 16.4 2500 1200 - seeds for hybrid corn 14.0 3650 1500 - corn for production 19.9 1020 442 of cereals and mixed fodder - barley for cereals and 39.0 700 292 mixed fodder Raw cotton 15.0 31 4000 400 2000 333 Non-fermented tobacco 32.5 64 5000 2500 Ist sort (from 1993's harvest) Seeds of Lucerne 0.6 10000 4000 Seeds of sugarbeet 0.6 30000 10000 Seed potatoes 14.4 2000 920 Livestock and poultry 31.6 4000 2500 Wool thin and semi-thin (clean fiber weight) 4.0 25 17000 1700 70 11000 1833 - in physical weight 8.0 8500 5500 * Assuming an average exchange rate of 10 som per $US in 1994, 6 som per $US for 1993. The market exchange rate in October 1993 was 8 som per $US, and in December 1994 it was 10.9 som per $US. - 10 - 34. A new decree issued in February of 1994 addresses some of the deficiencies in the program of land reform and farm restructuring. The duration of use rights for land under the new decree is to be 49 years, with a right to renewal. Although land remains in state ownership and cannot be bought or sold, use rights are marketable starting in 1995. The decree clarifies administrative responsibility for implementation of the program of land reform, and designates the Ministry of Agriculture and Food as the lead agency, in conjunction with regional authorities and local committees. Implementation of the decree began in mid 1994, but a number of ambiguities remain in the legal basis for distribution of land and assets. The language of the decree is vague on the important question of entitlement to participation in the program, and will require clarification. 35. Restructuring of firms involved in processing and marketing accelerated in the first part of 1994. Marketing of agricultural inputs is still dominated by state-owned or parastatal monopolies. Major parastatal marketing firms are currently being prepared for privatization to take place in 1995 and 1996. A draft law on insolvency has been prepared to be submitted to Parliament. 36. During May 1994, a restructuring plan was announced for the monopoly buyer of wheat, the Bread Products Enterprise which, at present, comprises some 80 subsidiary enterprises. Under the plan, the majority of the subsidiary enterprises will be auctioned to the private sector, both domestic and foreign; and several will become joint- stock companies. The Bread Products Enterprise itself will continue on a transitional basis at least, owned by the State Property Fund, operating under the name Kyrgyzdanazyk. Management expects it thereafter to be privatized. The privatization and reorganization of the Bread Products Enterprise is a natural outgrowth of the very significant decline in the state's role in grain marketing during 1994. The reorganization will accomplish a transfer of assets to the private sector corresponding to the shift in activity out of the state sector that has already taken place. The assets remaining in state ownership will be used to implement public policy in grain distribution, such as assuring continuity of physical supply for needy groups and remote regions. This function is expected to be reduced in the future as income growth turns positive and interregional transportation links are improved. A parallel process of privatization is underway with the 150 enterprises that up to 1993 constituted Kyrgyz Tamak-Ash, the principal state agro-processing and marketing agency for major commodities other than wool and wheat. 37. Reform in the structure and function of local government has been insufficient to implement change at the local level. Farms are still formally under the jurisdiction of the Ministry of Agriculture and Food through the oversight of the local agricultural administrator. The reduced managerial capacity of the national Ministry of Agriculture and Food means that local administrators have more autonomy than they did in the past. Their powers in relation to farms are no longer clearly defined, but the farms are not yet fully independent economic entities. Although local governments retain many of the administrative prerogatives of the past that are no longer appropriate, new functions of local government, such as technical and financial advisory services, are not adequately developed. 38. Local agricultural officials could play an important role in implementing reforms. In order for local administrators to shift their activities out of administrative management of their local economies and into implementation of reform, a number of - 11 - changes should be made in legislation, allocation of tax revenues, and in job definitions of staff currently filling local administrative positions. If local officials currently have legal authority to intervene in decisions of private or corporatized enterprises with regard to production, trade, or pricing, legislation should be enacted removing that authority. Officials at all levels of government should be forbidden to interfere with interprovincial trade. Finally, the Ministry of Agriculture and Food should offer direction to local officials instructing them to concentrate on implementation of reform. The Policy and Regulatory Environment: Pricing, Marketing, and Foreign Trade 39. Pricing: Agricultural producer prices in the Kyrgyz Republic appear to be depressed relative to world levels, although the country's relative isolation from world markets makes it difficult to identify comparator prices with confidence. Furthermore, it is difficult to know what producer prices are because price information is scarce. Moreover, due to arrears in payment, producers do not necessarily receive prices specified in contracts. In late 1993 neither the Ministry of Agriculture and Food, producers, nor major buyers of agricultural products could report with certainty on actual producer prices. This lack of information on producer prices is indicative of the confusion prevailing in the monetized component of the agricultural economy, and explains in part why producers are retreating from it. 40. There is no systematic survey of producer prices, although retail prices in major markets are sampled. The producer does not necessarily receive the announced price at the time of transaction, and may instead receive only partial payment plus a promise of future payment. Producers are increasingly selling to private traders for prices lower than procurement prices, but paid on delivery. Reported cash prices in the fall of 1994 were considerably below announced procurement prices shown in Table 1. 41. Official procurement prices for 1994 for domestic supply are listed in Table 1. Contractual prices for grain appear to be approximately 20 percent lower than Kazakh export prices. Wool prices are lower than world levels by about 30 percent. Prices actually received may be lower than contractual procurement prices due to arrears in payment, and because producers sell for cash at prices below procurement prices. Procurement prices in 1992 and 1993 are shown in Statistical Annex Table 3. 1. 42. The prices that prevail in purchases outside state orders and domestic supply agreements are negotiated between producers and local branches of the conglomerates that manage procurement: The Warehouse Enterprises of the Ministry of Trade and Material Resources, the Bread Products Complex, Kyrgyz Tamakash (confectionery, beverages, vegetable oil, meat), and Kyrgyz Gemishi (fruits and vegetables). The pricing mechanism is one in which market activities have played virtually no role prior to 1994, except for the increasing proportion of food that producers market themselves under primitive conditions or to private buyers paying cash. The decline in deliveries to the state in 1994 has increased the scope for markets to function. 43. Beginning June 1993, almost all enterprises were subject to limits on marketing margins from 10 percent to 35 percent, including the smallest retail stores and - 12 - kiosks. Regulated markup margins were removed in early 1994 for all products except bread. In February 1994, the price subsidy on bread was eliminated. Bread prices increased by 150 percent and a targeted cash compensation scheme was introduced. 44. A number of additional measures should be undertaken to continue progress on liberalization of pricing and markets. The export tax on hides and skins and live animals should be removed. The 30 percent export tax on wheat should be removed. The Kyrgyz government should negotiate with neighboring governments to remove licensing and other barriers to cross-border trade that originate on the neighbors' sides. 45. As Kyrgyz producers are paid what they could earn in external markets, prices will in general increase. This process will not be immediate, since it will take time to strengthen private links with foreign markets, but it will happen over time. With higher prices the government will find it desirable to reduce procurement to the minimum needed to fulfill governmental obligations (such as to the armed forces and to people in institutions, and to meet bilateral trade commitments). The government will furthermore wish to shift to a system of competitive bidding for procurement, so that purchases are made at minimum market prices rather than administered prices. While bilateral trading commitments remain in effect, they can be fulfilled by authorizing trading firms to act as the government's agent in competitive bidding. 46. Administrative setting of prices is inconsistent with fully functioning markets, and administrative pricing should be discontinued. The introduction of the principle that the government pays full price and on time for purchased conmnodities will lead to a reduction of the state's influence over prices. The state's influence on prices can be reduced, if the following measures are taken: * Exports should be allowed even if the country is a net importer of a given commodity, such as wheat, so that producer prices cannot be artificially depressed below external prices. * The recent decrees liberalizing export opportunities should be rigorously enforced. * A decree should be issued expressly forbidding local agricultural officials to issue their own procurement prices, delivery requirements, or restrictions on trade across provincial boundaries. * Privatization and restructuring of parastatal marketing firms should continue, so that firms that remain in business have the financial strength to offer marketing services to producers. 47. Although the government's share of procurement will diminish, the government will remain a buyer of agricultural products. The rules for government procurement should be changed to be consistent with greater functioning of markets. Intentions to procure should be widely publicized and competing bids should be sought from suppliers. Procurement should be limited to quantities for which the government can pay - 13 - fully and on time at delivery. Procurement should not be linked to supply of inputs on preferential terms or to supply of credit to producers. 48. Marketing Policy and Foreign Trade. Clearing arrangements specify agricultural products, mainly cotton, wool, and tobacco to be exchanged on a barter basis between the countries of the former Soviet Union. The prices of the products are denominated in dollars and the quantities are computed to offset exactly the dollar value of exports against imports, although in practice accounts do not always balance. The Kyrgyz Republic has clearing agreements with Russia, Kazakhstan, and Uzbekistan. State marketing agencies purchase products at prices determined by the government, and their supply by producers is obligatory. The government has announced its desire to eliminate bilateral clearing agreements in 1995, and expand the role of direct trading between enterprises. In order to implement this intention, the government should continue with privatization of the firms engaged in marketing of agricultural products. Continued reform of the banking system to expedite interbank transfers of funds will facilitate growth of interenterprise trade with foreign partners. 49. Domestic supply contracts include products that are considered necessary for domestic needs. The state's purchase and distribution of these items are administered through a process akin to the state order system, although there is more scope for negotiations. Domestic Supply Agreements are established by requiring agricultural producers in the regions to provide production estimates to the MITMR. The processing and marketing enterprises are required to provide their demand forecasts for each product. The supply and demand forecasts are balanced by the Ministry of Economy and Finance. These balances are then sent back to each organization involved in the process for review and reconciliation. Procurement is implemented through contracts that are legally binding, but weak enforcement in 1994 has somewhat diminished the importance of domestic supply contracts. The Government Resolution of January 1994 specifies intended procurement for domestic needs in 1994. 50. Licensing requirements were in the past used as a means to ensure compliance with the various supply agreements. In March 1994, licensing requirements were removed for all agricultural exports. The 30 percent tax on exports of wheat, skins, and live animals is the only remaining formal barrier to agricultural exports. 51. Growth in exports is critical to the recovery of Kyrgyz agriculture. The domestic market has contracted, and the agricultural sector needs export markets to maintain current production and provide investment for a more competitive future. The recent reduction in trade barriers is a very important change in the regulatory environment that will benefit the agricultural sector. 52. An open trading regime will benefit the agricultural sector in two important ways. As trade barriers are reduced, domestic producer prices will rise to the level of external prices, since producers and traders can move product into external markets and force prices back up if domestic prices fall. Moreover, lower export barriers mean that earnings in hard currency and regional currency will grow, and both are needed. - 14 - 53. Several additional steps should be taken to increase exports now that licensing has been removed and export taxes on agricultural products (except wheat, skins, and live animals) have been discontinued. The Ministry of Agriculture and Food should widely publish information on prices on domestic and major foreign markets, and government intentions regarding procurement. A comprehensive review of grading and standards should be undertaken for export commodities so that product quality is measured according to international standards. Certified laboratories for testing and grading should be established, initially by the government, if necessary. These can later be managed by associations of conmnodity producers. Exchange Rate Policy 54. As a major exporting sector, agriculture is strongly affected by exchange rate policy. Demand for the som has reportedly strengthened in the region, while neighboring currencies are reportedly weakening against it, and the som's rate of nominal depreciation against the US dollar has slowed. This is a reflection in part of slowing domestic inflation resulting from prudent fiscal and monetary policy, and in part related to the inflow of concessional funds. 55. These changes are welcome as a sign of macro-economic stability, and their impact on agriculture must be closely monitored. Should the currency appreciate in real terms to the point at which it becomes significantly overvalued, the overvaluation would represent a new, distorting and unwelcome source of downward pressure on agriculture's already low profitability. Subsidies and Taxes 56. The policies on pricing and marketing that prevailed through 1993, as described above, constituted a substantial indirect tax on agriculture, although its magnitude is unmeasured. Primary agriculture has received three kinds of subsidy to offset the implicit tax: subsidized credit, informal arrears, and subsidized water. Although these subsidies are large in magnitude, the net effect of subsidies and indirect taxes has been to transfer resources out of the sector and to depress producer incentives. 57. Directed credit was extended to agriculture at preferential interest rates throughout 1993, after which preferential interest rates were discontinued. For example, in October 1993, Agroprom Bank was instructed to provide special credit to the state and collective farms in order to complete the fall harvest, which was in jeopardy due to sharply higher costs of fuel and the shortage of spare parts for machinery. The NBK provided the funds to Agroprom Bank at the credit auction rate of 190 percent with the understanding that the government would subsidize the rate by 90 percent. Corresponding implicit subsidies occurred earlier in the spring of 1993, when interest rates on six-month farm production loans were set at 53 percent-well below the existing rate of inflation. Banks report that the budgetary subsidy was not paid in full, and thus the banks, rather than the budget, paid part of the cost. - 15 - 58. The second form of agricultural subsidy is not well measured and consists of accumulating arrears in payment. Agricultural producers, like other economic agents, are caught in a web of arrears in which they are both debtors and creditors. According to estimates of the IMF, total arrears in the economy increased from 1.8 billion som in December 1993 to 3.4 billion som in March 1994. Subsequent efforts to clear the backlog of arrears have reduced the total. The existence of arrears of this magnitude is symptomatic of the deterioration of the commercial and monetized component of the economy. 59. Traditionally internal reserves were expected to cover approximately one quarter of farms' financing needs, but in current circumstances of low earnings and high debt, internal reserves are probably very low. Informal financing through accumulating arrears remains large. Arrears are a form of implicit subsidy unless they are paid off in full with interest accumulated at the market rate. Inter-enterprise arrears, however, do not carry a direct budgetary cost. 60. The third form of subsidy is in the price structure for water charges. Charges for water use were introduced in 1992, but collections do not cover the variable costs of delivering water, and the budget pays the residual cost of operating the irrigation system. 61. The bread subsidy was formerly large, but it has been discontinued and replaced in 1994 by targeted cash assistance. Bread is the most important consumption item in the diet of poor people, and continued access to bread or flour is the highest priority of targeted assistance. Poor rural consumers in dispersed villages can meet their dietary needs more cheaply by buying flour than by buying bread, and the redesign of the assistance program should anticipate increased flour sales in rural areas and decreased demand for bread. Increased supply and regular delivery of flour at the retail level in rural areas will be important, as will targeted monetary assistance to poor families. The assistance can be less than the full cost of the increase in bread prices plus transportation and distribution, since many poorer households will make bread instead of buying it as the price rises, and flour is cheaper than bread to transport and distribute. 62. Agricultural producers pay explicit taxes in addition to the implicit intersectoral transfers collected through the pricing and marketing regime. Most important among these are the value added tax, the profit tax, and the land tax. The types of taxes theoretically levied on farms, supporting organizations and agro industry for 1993 and 1994 (together with expected-but not achieved-realizations) are as follows: - 16 - Tax 1993 1994 million som million som Land tax 4.0 79.2 Profit tax 22.5 49.0 VAT 82.3 194.5 Emergency fund deductions 7.4 Road tax 3.9 9.5 Property 0.7 0.3** Total 120.8 332.5 * In 1994, most agricultural enterprises were exempted from Energy Fund deductions. ** Agricultural enterprises are normally exempt from property tax. Source: Ministry of Finance. 63. In addition to the taxes listed above, local taxes are also payable by agricultural enterprises to oblast and raion authorities. There appears to be no legal basis for this, and rates are reportedly ad hoc. 64. Nationally the taxation system is in disarray and efforts are underway to strengthen it. Tax collection in the final quarters of 1993 had fallen to 7.3 percent of GDP, compared with a desirable range of 20-25 percent, and by January 1994, the collection rate had fallen further to 2.6 percent. A major review of tax rates and administration is currently under way. 65. In further review of agricultural taxation, it is desirable that agriculture be treated the same as other productive sectors, without special harshness or leniency. A land tax is, in general, a good form of taxation because it collects revenue without much distortion of producers' decisions about what and how to produce. A significant land tax also encourages owners to see that the land is used and not left idle. An excessively high land tax, however, will discourage people from seeking private ownership through land reform. This will be the case if the tax is so high that it absorbs much or all of the financial returns to land even in areas where land has little alternative commercial use besides agriculture. To avoid double taxation, land tax should be subtracted before profit tax or income is calculated. 66. The mechanism of assessment for the land tax should evolve over time to reflect the commercial and market value of land, and rely less on formulas derived from the potential agricultural yield. In the immediate period, before land markets become active, there is little alternative to assessment based on the traditional measure of soil productivity, the bal. In time, however, as land markets are more active, the potential value of land in commercial use, whether agricultural or other, should be the basis for assessment. For example, in parts of the United States where agricultural earnings are low but commercial demand for land is high, land tax exceeds the financial return to land as a productive agricultural asset. In other parts of the U.S. where agriculture is profitable, land tax amounts to about 20 percent of the rental rate for land. The rental rate, in turn, is the return to land after payment for purchased inputs, finance, and labor, including imputed earnings of the - 17 - farm operator. Rental rates are determined on land markets, while tax rates are set by governments according to formulas based on the assessed value of the land. Agricultural Finance 67. Among the approximately 20 commercial banks, four banks can be considered agricultural lenders through their extension of credit to farms, farm commodity and input procurement agencies, the food-processing industry and various input suppliers. These are the Agroprom Bank, the Kyrgyzstan Bank, the Promstroi Bank, and the Dyikan Bank. The formal agricultural credit system remains highly concentrated. Supplier credit, under which companies selling inputs finance the purchase, is virtually nonexistent at present. 68. Reforms within the banking and rural credit system have evolved slowly. The banks do not operate as independent financial intermediaries that pool the funds of savers, appropriately transform the rate, maturity and denomination characteristics of those funds for lending, and pool the risks of borrowers. Instead, the banks act more as "cash managers." Their primary function continues to be providing cash to meet enterprise liquidity needs, typically by channeling high-cost short-term bank funds into loans with matching maturities and the only nominally higher interest rates. Loan rates throughout 1993 were highly negative in real terms, and interest rates did not serve their allocative function. This liquidity-driven funds allocation discourages loans of any significant length; long-term credit currently represents an extremely small share of total bank lending. For example, at Agroprom Bank, long-term loans represented less than 2 percent of total bank loan volume in October 1993. Agroprom Bank, Kyrgyzstan Bank, and Promstroi Bank carry high concentrations of loans with their major shareholders. This owner-borrower link is an unhealthy situation that discourages bank competition and jeopardizes the financial positions of the banks. 69. Two characteristics of the recent credit allocation to agriculture are important to note. First, an increasing share of the total, short-term bank credit to agriculture has gone to nonfarm agricultural activities (for example, commodity procurement, processing, and various state enterprises). Second, nearly all of the existing bank credit to farms has been allocated to the state and collective farming units with relatively little credit to the new individual and cooperative private farms. Moreover, the allocation of bank credit to farms has been dominated by production loans with terms of three to six months. The flow of investment credit (with maturities greater than one year) is insufficient to fund long-term capital improvement of the farm sector. 70. The problem of increasing arrears threatens both the level of financial intermediation in rural areas (because of the impact on the banks) and the monetization of the agricultural sector (due to the impact on farm financing). The result has been a reduced cash flow to the farms, which have been unable either to pay their workers or to repay the banks on time. An analogous financial problem has occurred in the rural branch banks. Consequently, bank refinancing of existing farm debt increased during 1993, and became a significant (but difficult to quantify) part of the observed expansion in farm sector lending. Successively higher nominal interest rates have exacerbated the problem of nonrepayment, since the banks applied the higher interest rates plus rate penalties to the refinanced loan - 18 - balances. This situation caused increased financial stress among farms, many of which were already technically bankrupt. Increasingly illiquid farms are retreating from monetary transactions into subsistence and self-sufficiency. Moreover, as highly indebted farms enter the process of privatization and restructuring, shareholders are reluctant to assume genuine ownership if this entails assumption of debt. Inherited debt is thus a constraint on privatization, as well as on current production. 71. The financial problems of the agricultural sector have progressed without the occurrence of massive bankruptcies because the banks have not been required to collect on bad debts or to make sufficient provision for the uncollectible portion of their loan portfolios. Moreover, the banks have elected not to use the existing law on insolvency to break the circle of arrears. Rather, the banks have continued to follow a defensive lending strategy where additional (refinancing) loans are provided to cover enterprise losses and postpone bankruptcies. Additionally, the banks have proceeded to shorten maturities on new agricultural loans to three months, and to redirect their lending efforts toward commercial activities (where profits, sales turnover, and repayment capacity are stronger). The net effect of these banking practices has been to reduce the availability of investment credit for primary agriculture, to reduce the overall allocation of bank credit to agriculture, and to postpone dealing with both the problem of accumulating arrears and the threat that nonrepayment of loans poses to the banks. 72. As part of the existing process for allocating agricultural credit, the Ministry of Agriculture and Food (MOA) has annually estimated the amount of operating credit that is required by state and collective farms. Traditionally, the resulting estimate of farm credit "needs" has been forwarded to the NBK as part of the state planning process, along with the estimated "needs" of the other ministries. 73. The methodology of the Ministry of Agriculture and Food has several deficiencies that affect the resulting credit estimate. First, the calculation of expenses requiring credit appears to ignore several important expense items (for example, labor and interest). Thus the estimate of credit need is too low. Second, the calculation assumes too little change in the structure of production from one year to the next and builds the existing operating inefficiencies of the state and collective farms into the credit estimate. For this reason, the estimate is too high. A third problem arises from the assumption about retained farm earnings, which is overly optimistic under current circumstances. 74. It is unlikely that agriculture will be granted credit in the amount estimated by any formula, nor would it be advisable to launch a large program of targeted lending. The estimation of credit needs is methodologically weak, and probably not relevant to the current situation. Substantial continued directed lending to agriculture undermines efforts to control inflation. The estimate of credit "needs," either under the Ministry of Agriculture and Food's methodology or alternative approaches, serves primarily to demonstrate that "needs" as traditionally defined cannot be met under current circumstances. Farms must substantially increase their ability to self-finance by selling animals, by orienting themselves toward export markets where prices are higher, by reducing costs, and by raising productivity. The low prices, mandatory deliveries, and export barriers in effect throughout 1993 caused damage to farm finances that neither the budget nor the banking system can - 19 - redress. Farms must rebuild profitability and earnings through internal reorganization in an environment that offers better economic incentives than in 1993. 75. Solutions to the problems of agricultural credit will take some time to implement, and will require improved incentives for agriculture, privatization of farms, and full reform of the banking system. Clearly, short-term measures are needed for the interim. It is very important that applicants for credit be more carefully screened than in the past. Production credit should be secured with collateral in the form of liens on crops and livestock and additional collateral where available, and not used to roll over past debt. Subsidized credit should be phased out as state orders are dropped and pricing and trade are fully liberalized, and this should take place in 1994. Reduction in inflation achieved in 1994 will bring nominal interest rates down, and make it possible for more agricultural producers to qualify for loans. 76. Banks should adopt improved methods for evaluating credit applications and managing the loan portfolio. All farm borrowers should be required to prepare a brief business plan which informs the bank about the existing financial position of the farm and the plan of farming operations. The plan should clearly show the projected cash flows of the business, and the repayment of debt. The contents of a sample plan are shown in Annex Chapter 1. The banks should actively use this information to screen borrowers before lending and to adjust the amounts, terms, and conditions on loans that are granted. Farm business projections should be modified appropriately by the banks to reflect expected rates of inflation. The use of business plans and credit criteria to assess the creditworthiness of farm borrowers, and to change bank procedures for administering loans, will require that expert technical assistance be provided to develop credit manuals and to train the bank managers and loan officers. This technical assistance should be provided in the context of training and the implementation of best practices in all aspects of rural banking at the earliest possible stage of sector adjustment. 77. The banks are currently carrying significant amounts of loans which are in arrears and are not likely to be repaid. The banks should be required to charge off the uncollectible loans. They should also be assisted to collect on loans where a significant recovery is possible, and should be encouraged to restructure the nonperforming loans of financially viable farming operations. As part of that strategy, the banks should be allowed to increase their spreads on loans. By improving the financial health of the banks the prospects for expanding the availability of long-term funds in agriculture are also improved. The future of Agroprom Bank should be determined within the context of an overall strategy for the financial sector. 78. The current banking system largely ignores small, private farms. A number of factors contribute to this situation; among which are high unit transaction costs of small loans, lack of assets for collateral, a high level of subsistence activities, unproven management, and poor records. Improving access of small farmers to credit requires that banks work more closely with small farmers. Before that can occur, however, there is need for a clearer understanding of how these farms function and how they can repay debt. The Kyrgyz Republic should commission a short-term study with the assistance of donor funds, and should develop an appropriate strategy for providing financial services to the emerging small-farm population. The relative merits of grants versus loans should be considered to - 20 - finance start-up costs of private farms. The initial investment costs for private farms elsewhere in the former Soviet Union have been found to be relatively low, for example, about $4,000 for 40 hectare farms in Russia. There are few sources of genuine loans for such initial investments, and many loans in fact have a high proportion of de facto grant. Although grant financing may be appropriate for initial capital, private farmers should not need grants for working capital. Financing of operating expenses should be through financial markets with rigorous screening and security for the loans. New Role for and Structure of Government to Support Reform 79. There is at present little public understanding of the cause of the agricultural decline or confidence that reforms can arrest it. A critical ingredient for sectoral recovery is stronger intellectual leadership and public education to articulate the problems of agriculture and identify solutions consistent with the overall reform program. The Ministry of Agriculture and Food should provide intellectual leadership for the debate on agricultural issues within the more general dialogue about economic reform. This leadership should include a vision of a more prosperous agriculture constructively embedded in a market economy. 80. A number of changes will be required in the structure and function of the Ministry of Agriculture and Food and in the government's role in the sector. The diminished role of government in a market economy and the fiscal constraints of the current period of crisis argue in favor of a smaller Ministry focused on the legitimate tasks of the public sector. These include analysis of policy, implementation of reform, dissemination of information, support for education and research, and enforcement of standards for health and safety and product quality. The functions of local government officials should be redefined to focus on implementation of reform and provision of information. Local governmnent officials should explicitly be precluded from administrative interference in production or marketing. Farms should be removed from the administrative jurisdiction of local agricultural officials in matters of economic management. 81. The Ministry of Agriculture and Food has undergone some reorganization, but further change in structure will be needed to increase the Ministry's effectiveness. As alternative structures for the Ministry are considered, a number of considerations should be taken into account: * There should be one Minister of Agriculture and he or she should have undivided responsibility. * Production, processing, marketing, and input supply should be privatized, and departments supervising these activities should be deleted from the new structure. A department managing procurement on the government's account under competitive procedures should be retained, but government procurement should be at a greatly reduced level. * The size of the Ministry should be modest, reflecting budgetary constraints and the new more limited role of the government in the sector. - 21 - * The province and district-level agricultural departments should be redefined as units offering information and advice, but not administering production or marketing. * The departments of the Ministry should reflect its primary functions, such as implementation of reform, support for agricultural research, provision of technical and advisory services, enforcement of health and safety standards and environmental regulations, and provision of economic information and analysis. 82. A sample organizational structure for the Ministry was presented by an earlier mission of the World Bank, and is presented for reference on the next page. 83. The redefinition of the activities and authority of local government should be undertaken as a matter of urgency. Experience in other countries of the former Soviet Union has shown that where local officials retain authority to influence pricing, marketing, and trade, producers are often denied the opportunity to participate in national and international markets. National markets cannot emerge and national policies cannot be implemented if local officials can choose to pursue alternative objectives. Excessive localism creates large efficiency losses and reduces the benefits of reform, thus retarding progress and eroding support. 84. Moreover, continued interference of local officials in economic management leaves too few resources for tasks that are traditionally the responsibility of local government. Foremost among these in the Kyrgyz Republic is attention to animal health, particularly brucellosis eradication. The private sector will eventually share in provision of veterinary services, but in the short run local governments must attend to this problem in the context of a national program. Producers, whether private or in collective enterprises, need additional information about marketing and financial management, and local government is the appropriate provider of support in this area until the private providers of services are active. 85. Government at the national level should retain responsibility for agricultural research and education. The research system will need review. Applied research supporting key components of agricultural recovery should continue to receive support, even as the overall level of funding for research declines and duplication in the research program is eliminated. Among the priorities identified in this report that the research agenda should address are: v Improved animal health and productivity * Restoration of pasture productivity * Alternative technologies of crop management that are less intensive in input use, including seed trials, fertilizer management, vermiculture and composting, and use of micronutrients * Analysis of the economics of alternative production regimes, rather than the traditional emphasis on yields. Proposed Organiational Structure of the Ministry of Agriculture and Food Administration, Hwman Land Reform Research Technology and Regulatory and | Economics Project Development Resouces, Fin;nce, Legal Advisory Services Oter Semrces Unit Foreign Assistance - Assistant to Rural amd Crops ensicn Quaatine - Market Information Village Commninlees -vestoc Plant adection - Analysis of Sectora Performance - Land Registration, Surveys, Wod Vete* and Policy Alternaives Titling - Soil and Water Coservation - Maiet fastrurtuie Inspection and Coirol- Technology Traisfer EnMronment Prdecion Development Farm Restmectwirg - Commwecatibons ForICtiy Export Prmdion - Farm Managemned L Trainng - 23 - Land Reform and Restructuring of Farms 86. Land reform and restructuring of collective and state farms present some of the most difficult problems of reform in the agricultural sector. 87. Land reform andfarm restructuring should be pursued in order to create more efficient farm units, rather than for ideological reasons. The agricultural work force will be able to enjoy an adequate standard of living in the future only if farms become more efficient than they have been in the past. The objective of land reform and farm restructuring should be improved efficiency and profitability. "Privatization," or "creation of diversity of ownership" should not be goals in and of themselves. 88. Policy and programs create the processes of land reform and farm restructuring, but do not assure a given outcome. The structure of ownership and the farm size that will emerge from land reform and farm restructuring is not yet known, nor is there one clear optimal structure. The program should be understood as one that establishes and implements a process, rather than one that guarantees an outcome. 89. Fundamental to the processes of land reform and farm restructuring are definition and assignment of clear property rights in land and farm assets. Property rights define the kind of tenure a landholder has, and what he or she can do with the land. These rights are fundamental in the sense that they should be protected by law from revocation, reinterpretation, or infringement. 90. Transferability of property rights, preferably through market transactions, is as important as initial assignment of rights. The improved efficiency that comes from land reform and farm restructuring is not captured immediately, but derives from incentives for owners to invest in their properties and manage them well. Both investment and management are enhanced when rights are fully marketable. Conversely, constraints on transactions in land severely limit the gains that can be expected from land reform and farm restructuring. 91. In order for land reform and farm restructuring to achieve objectives, discriminatory price and marketing policies must be removed, financial services enhanced, and provision of support services from the public and private sector increased. If the economic environment is inhospitable, few farms will choose to reorganize. Moreover, the gains from structural changes will be reduced if farms do not have access to markets, and are instead forced into the administrative relationships of the old system. Privatization under conditions that depress farm profitability will create persistent rural poverty instead of growth. 92. The Kyrgyz Constitution, adopted in May 1993, does not sanction full private ownership of land. Article Four states that "the land, its subsoil, water, airspace, fauna and flora -- all natural resources, shall be the property of the State." The Article goes on to say that "plots of land, in the procedure and size provided by law ... may be given to citizens and their associations for private use. The purchase and sale of land shall not be allowed." The Constitution thus currently constrains optimal management of agricultural land through constraint of tenurial rights. A constitutional amendment to allow full private ownership of - 24 - land, including purchase and sale, is expected to be presented for Parliamentary consideration in 1995. 93. Full private ownership of land, with the right to buy and sell, is the optimum tenure form. Full ownership rights best promote investment in land, which leads to higher productivity. Active land markets give land an observable value upon which farmers and lenders can base business decisions. Marketability of land promotes growth in agricultural output by allowing producers who are most efficient and most motivated to expand their land holdings. Conversely, those who do not do well can sell their assets and seek other employment, instead of leaving with nothing. 94. When private land ownership is prohibited, the best economic alternative is to allow secure and marketable long-term use rights. The February 1994 decree on land reform provides for 49-year fully marketable use rights. As this decree is implemented and recipients of use rights understand and exercise their tenurial rights, land markets should begin to function. Public education regarding the new rights will be an important task for those implementing the decree. In addition, the former tenure status, including short-term use rights, lifetime possession, and other forms will have to be formally changed to conform to the new decree. 95. In an early component of the land reform program, the National Land Fund was created in 1992. The National Land Fund is a mechanism for redistributing land rights, but its principles of operation are not fully clear. According to the decree of February 1994, the National Land Fund will include 25 percent of arable land excluding pasture, with the intent of transferring ownership of this land to qualified applicants. Among the qualities considered are ethnicity, since the original intent for which the National Land Fund was created was to increase access of ethnic Kyrgyz to irrigated crop land. 96. A number of problems arise concerning the National Land Fund. The mechanism through which land is designated for the Fund and allocated to new users is not clear and therefore subject to abuse. The relationship between allocation of land shares to farm shareholders and distribution of land from the fund is not clear. The legal framework within which the Fund is managed should be clarified, including the intended duration of the fund. 97. If the purpose of the National Land Fund is to redistribute land tenure rights in favor of people not entitled to land shares, alternative approaches to achieving this goal should be considered. In the early period before land rights were marketable, the National Land Fund was the only mechanism through which people not entitled to land shares could enter farming. Now that land rights are marketable, market transactions rather than allocations from the fund, can facilitate entry of new farmers. Instead of designating actual tracts of land for the National Land Fund, the Fund could instead become a monetary program that gives preference to qualified applicants in financing the purchase of land use rights. People eligible to participate in the land reform could receive land rights regardless of ethnicity. As use rights come on the market in the future, qualified applicants could receive preferential financing through the money set aside for the National Land Fund until the stated goals of the program are met. This approach to implementing the programs of the National Land Fund would create some distortions in land markets, but would be less - 25 - disruptive and less subject to abuse than outright confiscation of land and redistribution through the fund. Confiscation of land, redistribution to people who may not be prepared adequately to cultivate it, and insecurity of tenure exacerbate the decline in production at a timne when the sector and the country can ill afford it. A more gradual transfer through market transactions would be preferable. 98. The mechanism for farm reorganization is distribution of shares in land and assets to entitled participants. The share system in the Kyrgyz Republic is basically similar to its analogs in other countries of the region, with the notable exception that state and collective farms are treated differently. Members and employees of state and collective farms receive two shares, one for land and one for assets. They can choose to keep their shares in a collective enterprise, or withdraw to form a private farm. 99. In the process of distributing shares, collective enterprises formally reorganize and register as a new kind of farm. Reorganized farms exhibit considerable diversity even if they are technically the same type of enterprise. Each organizational definition stands for a wide variety of organizational forms, and may exaggerate the reorganization that has actually occurred. Definitions of different types of enterprises should be clarified. The types of enterprises currently allowed include peasant (private) enterprises and their associations, cooperatives and their associations, larger group farms (although these are often called peasant enterprises by their leaders), joint-stock companies, and state and collective farms. Mechanisms for further reorganization, including the right to exit in the future from state and collective farms, should be stated explicitly, since the agricultural economy will undergo further change. The decree of February 1994 calls for issuance of implementing procedures clarifying the process of share distribution and reorganization of farms. Procedures should allow for withdrawal of shares by individual shareholders, or by groups in contiguous land shares. 100. Because of the importance of irrigation and pasture, producers even in fully privatized agriculture will generally have joint responsibility for management of irrigation within the boundaries of the former state or collective farm, and will generally graze animals on joint pasture. Associations such as water users' associations are likely therefore to be of great importance for private producers, and their functions and rights should be defined during the privatization. Water users' associations are described in more detail in Annex 3. 101. The procedural rules for farm reorganization should govern both land and non-land asset shares of collective and state farms, and make clear that both types of shares are inheritable. Internal transferability of shares allows members to assemble a desired mix of assets before exiting to start other kinds of farms. It is also desirable that shares be marketable outside the enterprise. Full marketability of asset shares gives managers incentives to increase the value of shares through proper economic management. This occurs because owners of shares are concerned about their value, and encourage the manager to earn profits. 102. Full marketability of shares is particularly important for farms that reorganize as joint stock companies. For example, where large sheep farms are engaged primarily in stock improvement through selective breeding programs, it will in some cases be desirable to preserve the large scale of operation. In this case, the employees and members of such - 26 - farms should receive shares in a joint-stock company, and the shares should not be redeemable in kind if the person chooses to leave the farm. If the shareholder wants to exit, the shares will be sold either inside the farm or to outside buyers, and the owner will use the cash to make an alternative investment. If the joint-stock company is of the closed form and shares can be sold only to other members, the value of shares is likely to be low. For those farms that choose to remain as single units under the joint-stock form of organization, open companies with tradable shares are preferable to closed companies. These farms will become genuine corporate farms. 103. There are likely in practice to be very few farms for which economies of large-scale production are great enough to justify keeping the traditional farm intact as corporate farms. These few farms should reorganize as open joint stock companies. Many farm employees at present, however, think that large-scale production is more efficient, and prefer not to become individual private farmers. Those who choose to remain in group farming at present should be encouraged to do so in associations of private farmers or in other kinds of farms in which they retain the right to exit with shares of land and assets. A true shareholder in a corporate farm cannot take physical assets upon exit unless the corporation is dissolved. In the review of the program of farm restructuring, special attention should be given to the problem of exit. The right of individuals to exit should be safeguarded, but exit should not unduly compromise the viability of the farm enterprise. In most cases, an association of peasant farms will be the superior form of organization, since land parcels will be identified and tenure secured for the individual or household. The association would still farm collectively, but individuals would not give up their ownership of real assets. The association could determine exit procedures for those who choose to leave in a way that would minimize disruption of production. 104. The state should develop a list of enterprises engaged in breeding of high- quality genetic stock. Enterprises engaged primarily in commercial production of meat and milk, even if they sell some breeding stock, should not be on the list. For enterprises on the list, the relative merits of privatization intact as joint stock companies, or splitting into smaller units should be considered. Farms not on the list will, in general, be more successfully privatized as associations of peasant farms or through splitting into smaller business units. 105. Various legal enactments, discussions with government officials, and field observations all indicate that at present collective farms and state farms are treated differently in the reorganization process, apparently because collective farms are deemed owned by the members while state farms are owned by the state. Members of collective farms receive a share of assets without payment, and state farm employees are expected to pay, either in vouchers or cash. Under current economic conditions, few employees of state farms have money with which to purchase shares. Furthermore, there is not yet a clear mechanism with which the value of vouchers can be applied toward purchase of asset shares, since the value of shares and vouchers may not correspond. Within the large and diverse region now undergoing decollectivization, the practice in Eastern and Central Europe has been, in general, to treat state and collective farms differently. Privatization of state farms has been delayed in these countries and has been problematical. In most of the former Soviet Union, where the share system predominates, state and collective farms are usually treated in the same way. The problems that arise thus tend to be the same for state and collective farms - 27 - and separate solutions need not be designed. For reasons of administrative simplicity and speed, it would be advisable to treat state and collective farms in the same manner, and apply the share system equally to both. Members of collective farms, employees of state farms, and eligible pensioners would receive entitlement to land and asset shares without payment in cash or vouchers. 106. Land reform and restructuring of farms in The Kyrgyz Republic needs stronger direction from the national level, and enhanced compliance and implementation at the local level. 107. The decree of February 1994 creates the legal basis for improved implementation in several ways. Authority for direction at the national level has been given to the Ministry of Agriculture and Food, instead of divided among agencies, as in the past. At the local level, rural committees will participate in implementation. Local state administrators retain a substantial role, including that of setting up local committees and supervising their activities. The problem of excessive localism in interpretation and implementation of the program that weakened the reform in the past may thus persist. 108. In addition to strengthened procedures for national oversight and local implementation, separate procedures for adjudication of disputes should be set up and put into effect. At present complainants write to the Ministry of Agriculture and Food, and there is virtually no mechanism for clarification or redress. 109. Documentation of land rights should increase as land reform proceeds. Documentation of land rights provides people with information about a parcel of land. Documentation confirms rights, increases owners' willingness to assert those rights, and makes possible a market for land transactions. Documentation usually enhances security of tenure. 110. Present documentation of land rights varies widely. Different types of certificates documenting land rights appear to be in use, and not all people entitled to documents have them. A uniform land right certificate should be quickly designed and issued. The certificate should go not only to private farmers, but also to people on collectivized enterprises who have the right to withdraw land as they choose. The certificate affirming right to a land share of a given size can be issued quickly, and should show the kind and duration of tenure right. The right to an abstract parcel can be turned into right to an actual piece of land by specifying provisional boundaries on the document, and does not require complex land measurement efforts. Water rights and grazing rights associated with the land should be recorded on the document. As markets in use rights begin to develop, a full land registration system will be desirable. 111. Public information interpreting the legislation and informing people of their opportunities should be distributed. In field interviews mission members found that farmers, farm enterprise leaders, and even local officials were often uncertain about the status of the laws concerning land reform and farm restructuring and their rights under them. The problems of excessive local control noted above are exacerbated by insufficient knowledge. Radio and television can be used effectively to inform the rural population about land reform. - 28 - 112. The Kyrgyz Republic's program of land reform and farm restructuring has been started, stopped, and redefined since 1991. These changes in the program and uneven implementation have created uncertainty for all potential participants. Even with the Presidential decree of February 1994, a number of issues remain open, including program design, procedures and authority for implementation, and consistency with other laws and decrees. 113. It is, therefore, desirable to review thoroughly all aspects of the program. The review should be completed by fall of 1995, so that implementation can be resumed on a stronger foundation in 1996. 114. The review should include the following issues, among others: * Clear definition of eligibility for participation. * Definitive review of the legal foundation for the programs, including gaps in the legal framework and contradictions between and among existing laws and decrees regarding land reform and farm restructuring. * Presentation of options regarding the National Land Fund. * Procedures for inclusion of water and grazing rights in the program. * Definition of responsibilities for implementation at all levels of government. * Creation of a mechanism for monitoring of implementation, registering grievance, and redress. Non-governmental and academic organizations should participate in monitoring. * Design of a program of public education. 0 Design of procedures of redress for cases in which land was improperly distributed between 1991-94, or in cases in which farm members wish to reopen the issue of farm reorganization. * As part of the public education program, development of sample plans for reorganization according to major options, implementation of pilot reorganizations and dissemination of information on the progress of farms reorganizing through pilot programs. Several pilot reorganizations have already been initiated. 115. In the interim while the review is underway, farms should be free of administrative oversight by local agricultural officials. The farms should, therefore, be accorded status as autonomous business units. In order to safeguard the value of farm assets up to the time of formal privatization, decisions to sell or distribute farm assets, including equipment and animals, should be taken only with the approval of the farm's general assembly or board of directors. Farm managers should be held accountable for disposition of all farm assets in the interim period prior to privatization. Because these assets are at risk - 29 - during this period, the review of the program should be conducted as expeditiously as possible, and delay should be avoided. Privatization of Marketing and Services 116. There are six state-owned or controlled organizations that handle the marketing of agricultural products and distribution of inputs in the country. Privatization of these enterprises was recently accelerated. Most of the privatization through the end of 1993 entailed co-privatization with transfer of a portion of shares to the work force. 117. MITMR Warehouse Enterprise. The Ministry of Trade, and Material Resources (MITMR) is a major wholesale and retail distributor of agricultural and food products in the country. Its marketing operations comprise three specialized wholesale enterprises and nine regional trading enterprises. The commercial functions under the MITMR should be corporatized immediately. Much of the storage and distribution capacity of MITMR has already been privatized to labor collectives. If these private firms have financial difficulties in the future leading to a further round of restructuring, the enterprises should be split up and sold in order to increase competition. Transport still owned by MITMR should be privatized in a manner that creates competition. 118. The Bread Products Concern: This is a conglomerate of state enterprises consisting of 13 milling enterprises which operate Il1 grain and feed mills, 28 bread factories, and over 100 small bakeries throughout the country. It handles about 85 percent of the total grain marketed in the country. A major reorganization of the Bread Products Concern was announced in May 1994, including privatization of a portion. Implementation of this privatization plan in a way that creates competition will be a major institutional advance for Kyrgyz agriculture. 119. Kyrgyz Taamakash: Kyrgyz Tamakash is another conglomerate of 150 food processing enterprises, of which 45 have been privatized as joint-stock companies and 34 are classified as monopolies. It handles about 90 percent of all processed food, including meat, tobacco, and cotton. Most of its products are distributed by the MITMR enterprise and the Consumers Cooperative. Under a privatization plan announced in February 1994, many of the subsidiaries of Tamakash will be privatized, and the remainder of the parent company will fulfill largely a service function. 120. Kvrgyz Gemish: Kyrgyz Gemish, now a joint-stock company, is a conglomerate engaged in the procurement, processing, and distribution of fruits and vegetables in the country. Although Gemish still controls several of its warehouses in the regions, its retail stores have been privatized. 121. FertilizerEnterprise: TheFertilizerEnterprise(Selkhozkhimia) handles both importation and domestic distribution of fertilizers, agricultural chemicals, livestock feed additives, and veterinary drugs and vaccines. It has regional warehouses and research and extension units that prepare demand forecasts, provide technical advice to farmers, and control the use and application of fertilizers and pesticides. Privatization of Selkhozkhimia has not yet been designed, and preparation should begin in 1995. - 30 - 122. Consumers Cooperative: The consumers cooperative union (Potrebsoiuz) dominates rural retail trade. It is an association of six regional cooperative unions with a total membership of 250 primary cooperative societies. The consumer cooperative operates three national, nine regional, and two district wholesale warehouses. It has also 3,500 retail stores. The cooperative purchases farm products and distributes them through its retail network. These include wool, meat, vegetables, fruits, grains, honey, and bread. It also purchases its flour from the Bread Enterprise and contracts the milling of its own grain to the mills of the Bread Enterprise. Because it is the only retailer in most rural areas, the cooperative is obligated by the Government to serve remote rural areas. An approach to its financial and organizational restructuring should be designed in 1995. As part of the restructuring, the consumer cooperative network should be released from obligation to maintain service in areas where cost of delivery exceeds returns. Lower cost ways of serving remote rural areas should be explored. 123. In addition to the enterprises listed above, there are two private marketing firms of note. The most important private enterprises dealing with agricultural marketing and fertilizer distribution are the Agricultural Stock Exchange and NIKA. 124. The Agricultural Stock Exchange: The Exchange, established by a Presidential decree in 1992, is actually a commodity exchange operating as a joint-stock company. Its members are large agricultural producers (mainly state and collective farms), farmers' associations, agroprocessing enterprises, the Fertilizer Enterprise, and the Agricultural Machinery Enterprise, as well as some private farmers. Its current operations are concentrated on supplying farm machinery and fuel to members. 125. NIKA: This is a subsidiary company of a Kyrgyzstan-Swiss Investment Holding Inc., and it is the only private company handling import and export of fertilizers in the country. It imports fertilizer in bulk and packs it at its own plant in Issyk Kul for domestic distribution and reexport to China and other neighboring countries. 126. Few state organizations or ministries provide support to the private sector, and more support is needed. For example, enterprises need help to keep accounts, prepare tax returns, set up business, and to contact suppliers and buyers abroad. In the long term the private sector will provide services, but in the short run new private entrepreneurs may need advisory services from the public sector. Much of the needed expertise is found in the traditional large marketing firms now in the process of privatization. The privatization plans for the large enterprises should create units that supply marketing services on a commercial basis to a wide range of clients, and not just the reorganized traditional firm. Strategy for the Crop Sector 127. Although there are some technical questions that need to be resolved in the crop sector, the overwhelming problem in the Kyrgyz Republic is one of economics. The severe economic distortions and financial disarray in the sector at present make it difficult to identify technical problems and observe underlying comparative advantage. - 31 - 128. Yields are falling largely because of a lack of financing to buy inputs. Low yields have a low income potential, but even this low potential is not realized because the state purchasing agencies have no funds to pay the producers. Producers are therefore unable to pay for the requisite inputs for the following crop. Producers cannot carry out adequate maintenance on machinery, irrigation, and structures. On the agricultural support side, well- qualified and experienced people are leaving the employment for which they have been trained. 129. Changes in price, trade, and marketing regulations and improved provision of financial services are key to improved performance of the crop sector. In addition, specific investments in processing would improve opportunities for marketing of crop products. These potential investments should be undertaken by the private sector, and will require careful financial evaluation in advance. Some investments with clear technical benefits may not be financially justified, but are noted here for further investigation. Among the investments with high technical priority are cotton ginning, sugar refining, and tobacco and textiles. Cotton ginneries should be renovated, since some are antiquated and dangerous. The capacity to mill sugar beet should be increased by both upgrading of existing plants and constructing small-scale plants in zones where production of up to about 5,000 hectares is foreseen. Processing plants for the manufacture of finished agricultural products with export potential, such as tobacco and textiles, should be upgraded. 130. At present, many private smallholders receive no formal advice. If privatization is to proceed, smallholders must be given assistance in matters relating to crop production, livestock production, and management of finance. Some overseas training of technical staff in the agricultural support institutes should be considered, with a view to giving a wider perspective of approaches, methodology, and achievements elsewhere. These advisory services are offered in market economies by the private sector, and by the public extension service. The organization, funding, and mandate of agricultural extension in The Kyrgyz Republic should be reviewed. Smallholders and large farms are at present in need of better advisory services for production, finance, and environmental management. 131. A number of technical investigations currently underway in research institutes merit additional support. Use of micronutrients may lead to increased yields, and should be investigated through a countrywide trials program over a period of two or three years. Different micronutrients, different carriers, methods and rates of application would be examined. The Institute of Farming has a promising trials program on vermiculture and compost production. Particular attention should be paid to the economics of commercial production in this area. Seed rate trials should be continued, especially for grains and alfalfa. Variety trials more generally should be continued. Fertilizer trials incorporating economic analysis should be conducted. The use of different crop (or even timber) species and varieties for the reclamation of saline soils could be an important contribution to resuscitating damaged areas. Finally, investigations on the use of drip irrigation to increase fruit and vegetable production are worth maintaining, although the cost of this technology may preclude its early adoption. 132. The research activities, as well as a number of important projects in the livestock sector, are currently weak because funding is uncertain, and the organizational status of agricultural research is unclear. The public sector should continue to support basic - 32 - agricultural research, while much of the applied research will be undertaken by private firms. The research portfolio should be reviewed to eliminate overlap and redundancy. Communication between and amonig institutes should be improved. Criteria for evaluating research proposals should be developed. Linkage with international organizations should be strengthened and may, in some cases, lead to external funding for some joint research work. Cuts will have to be made in the existing researclh program in order to protect the quality of core research. It is, therefore, necessary to develop criteria for determining the priority of activities in the existing research portfolio. Economic costs and benefits should be among the evaluative criteria used, but should not be the only criterion, since the benefits of some basic research cannot be adequately measured in financial indicators. The review of agricultural research should include examination of patent law and protection of intellectual property. Irrigation and Water Policy 133. Irrigation is a key input into the agricultural sector of Kyrgyz Republic, reaching over 80 percent of the arable land (see Annex 3 Table A3. 1). It has also been critical in maintaining and stabilizing agricultural crop production. Although yields are generally low for irrigated land by world standards, they are about four to five times higher than yields in nonirrigated areas. The irrigation is provided by a well-managed and maintained main system. However, the distribution systems among and within farms are generally in poor condition. The result is that only 42 percent of the irrigated area is classified as well-engineered while a third is considered irregularly irrigated. 134. Three key issues need immediate attention to assure the sustainability of irrigation in the Kyrgyz Republic. First, new institutional arrangements must be made at the farm level to manage and maintain the distribution of water within the former state and collective farms as farming units are privatized. Second, the financing of maintenance and operations of the existing systems imiust be secured and obtained, in a large part, from water users. Finally, environmental degradation of the irrigation systems and the irrigated lands must be guarded against through increased efforts to improve drainage and to reduce salinity and soil erosion. Water fees should finance most of the operating costs of the irrigation system, and water users' associations should be established as part of the farm reorganization. 135. The Kyrgyz Republic is the source of water for the five states of Central Asia. Water rights are negotiated in intergovernmental agreements. Cooperative resolution of interstate allocation of water through diplomacy is desirable. As distortions in agriculture are reduced, and as demand for electricity increases with economic recovery and growth of foreign demand, the optimal position of The Kyrgyz Republic in interstate allocation of water may change. Demand for water in alternative uses should be monitored as the cost structure for water use changes, so that Kyrgyz authorities will be fully aware of the country's preferred outcome in water negotiations. Negotiating strategy can be designed accordingly. The agreements reached with regard to regional access to water originating in The Kyrgyz Republic should reflect the high value of water and the advantageous position of the country as a water exporter. - 33 - A Strategy for the Sheep and Wool Sector 136. The government should continue efforts to give producers of sheep and wool access to domestic and foreign markets without marketing harriers or export constraints. The government should proceed with farm restructuring, first by reviewing the program in 1995, followed by vigorous implementation. Particular attention to grazing rights in design of land reform will be essential. The government should maake key public investments in research and extension for the livestock industry, and in an indepenldenit testing facility to measure and certify wool quality. If these measures are pursued, producers will reduce aniinal numbers to a level that is profitable and sustainable without environmllenital degradationi. The total sheep flock sustainable over the long run is estimated at about 6.0 millioni animals (compared to 8.7 million animals in 1993). The actual size of the flock will depend on economic prospects for sheep production as perceived by producers. 137. Changes in the Kyrgyz sheep and wool indlustry as the sector adjusts will be likely to be positive if the following elemenits are included: * Research, training and technical assistance for the hay and grain industries. - Deregulation of livestock and grain mar-kets to give prioducers free access to international markets. * Support for researcli institutions and for the c.;tahlishnment of an agricultural extension service to support private farms and smallliolders. * Continued and more thorough restructurinig of collective and state farms, rather than the piecemeal transfer of animals to the household sector. * Key investments to improve the marketability of wvool and sheepmeat on international markets. These investmiienits are shown in Box A4. 1, and include establishment of an independenit wool testing laboratory and wool sample collection systemn, among others. 138. As a result of degradation of winter pastures anid a continiued reliance on wool production from wethers (male castrates) kept over winter, the Kyrgyz Republic became reliant on relatively high-cost supplemental feeding for four to five moniths of the year. Shortages of grain in particular for feeding during 1991/93 have resulted in a higlh proportion of tender and broken wool. Effects of cold and grain shortage were even more severe in 1993/94 since the winter was earlier and harsher. 139. The solution to several problems in the sector lies in continued flock reduction to a maximum of 6 million sheep and a change in emphasis from wool production using ewes and wethers to wool and meat production from a flock oriented toward seasonal prime lamb. Such a strategy would aim to turn off young prime lambs from summer pasture at five to seven months of age and reduce the number of wethers held over winter. A growing market for younger prime lamb exists in the Middle East and could he further developed. - 34 - 140. If the country is successfully to implement a strategy of reduced flock numbers and increased prime lamb offtake from summer pastures, pasture currently leased to neighboring countries should be reclaimed upon expiration of the current leases. The summer pasture leased out is of greater value than the winter pasture leased in, and the leases should be terminated. In addition, a revitalized forage crop and feed grain base will be needed to supply the winter/spring requirements and to avoid the wool tenderness problems discussed above. 141. Ecological and economic factors have contributed to the fall in production and productivity in the sheep and wool industries. The Kyrgyz sheep population has declined from 10.2 million in 1985 to 9.1 million January 1993 with reductions still occurring to a level of 8.8 million in October 1993. Production of wool has fallen from 38,000 tons (greasy weight) to 32,000 tons over the same period. Production of mutton has fallen from 72,000 tons to 70,000 tons over the corresponding interval. The average greasy fleece weight per head decreased from 3.5 kilograms in 1989 to 3.0 kilograms in 1992. 142. In order to improve productivity and efficiency, animal nutrition and health must be improved, particularly the quality and quantity of the diet in winter. Producers with secure land tenure and defined grazing rights, full opportunities to market domestically and abroad, and facing prices that reflect quality differences will have incentives and resources to improve animal nutrition. Unless nutrition improves, there is no chance that productive potential can be reached. 143. The incidence of Brucella melitensis (brucellosis) in sheep is of particular concern because of the increased diagnosis of the disease in humans in the Kyrgyz Republic. The number of persons tested positive has increased from 15.5 per 100,000 people in 1992 to 17.5 per 100,000 people in 1993. The incidence continues to grow in sheep tested (it grew to 1.8 percent in 1993 from 1.0 percent in 1992) thereby placing humans in increasingly risky environments. 144. Although a five-year program has been formulated by the Veterinary Department to eradicate brucellosis in sheep and brucellosis and tuberculosis in cattle, insufficient funds have been provided. Vaccination and diagnosis for the control of brucellosis in sheep is obviously inadequate and not preventing a rise in incidence of the disease in humans or sheep. Some private owners are not cooperating in current diagnostic services provided by the government because no compensation is paid for sheep slaughtered or disposed of after testing positive. 145. The control of helminth and ecto-parasites is threatened by lack of funds to import veterinary medicines and drugs. Also, the use of vaccines against a range of diseases is decreasing; this increasingly exposes the sheep to a variety of infectious diseases. At present veterinary medicines are imported and relatively expensive. Producers must have access to world markets and world market prices in order to be able to buy veterinary medicines. The Kyrgyz Republic could produce many of these vaccines itself and the possibility of export in the future should be explored. Whether the medicines are imported or produced domestically, they should be priced at world prices. - 35 - 146. Recent reforms affecting sheep ownership, land rights and use, privatization policies and changes in prices for inputs and outputs have had an impact on the sheep industry. In several respects, the impact at present is negative. For instance, the rate of genetic improvement is slowed as inferior rams are used for reproduction instead of semen from superior selected rams. Diseases spread more rapidly as control measures are ignored, and fewer sheep are presented for brucellosis testing. Furthermore, there is greater potential for spread of this and other disease due to the use of rams instead of artificial insemination. 147. Private farmers and householders managing sheep must have access to information on improved management and must be required to participate in public programs of disease control. Private producers under appropriate incentives and with access to markets can be effective managers. The current incentives are inappropriate. When output prices are depressed and external markets are closed, it does not pay to invest in disease control or in superior breeds. As long as inflation erodes the value of monetary savings, excessive inventories of poorly fed animals represent an instrument of savings with a negative real return (but a return that exceeds the return to bank deposits). The poor condition of private and household flocks of sheep thus reflects the distortions in the economic environment, and does not indicate poor potential for private management more generally. 148. The wool industry is an important part of the Kyrgyz economy, with exports of wool and wool product exports constituting a large share of foreign trade. In 1992/93 wool production was equivalent to about 16.25 million kilograms clean weight, valued dornestically at 170 million som (US$21.25 million). At world prices, the value of Kyrgyz wool production would be approximately 30 percent higher. The Kyrgyz Republic represents about 10 percent of wool production in the former Soviet Union and 1 percent of global wool production. Over 75 percent of wool produced in the Kyrgyz Republic is classified as fine (fibre diameter of less than 25 micron). The main source of this fine wool is the Kyrgyzskaia Tonkorunnia breed, a derivative of the Australian merino (Table 7.1). On balance, however, the wool classified as fine in Kyrgyz Republic would be classified as medium to strong in Australia. 149. The low value added in primary wool production at present is a result of many factors including low productivity, depressed international wool prices, and severe discounts for greasy wool from The Kyrgyz Republic. A recovery in earnings depends largely on higher productivity, a recovery in international wool prices and significant policy and institutional change to overcome price distortions, inadequate market infrastructure, and serious problems in the quality of greasy wool. The financial problems of the domestic wool processing industry further depress producer prices, since producers risk nonpayment for delivery to domestic buyers, and instead accept low cash prices from foreign buyers. 150. The limitations on the carrying capacity of Kyrgyz pastures imply that primary production should aim at quality and strive for price premiums associated with it. The location of The Kyrgyz Republic (intermediate between markets of Europe, Russia and Asia), low cost labor, access to raw materials and an established textile industry enhance the prospects for development of the wool industry. In order to exploit these opportunities, a significant program of policy change and adjustment of the industry is required. Needed actions can be categorized separately into four sub-groupings. They are shown in more detail in Box A4. 1, and include the following: - 36 - * Deregulation, with the aim of lifting constraints on development of the industry. These measures include the removal of price controls, export licenses, marketing constraints, and a range of direct and indirect taxes on exports. A number of measures were undertaken in 1994. * Programs to develop the market infrastructure of the wool industry within The Kyrgyz Republic. These measures are designed to enhance the level of support service in the industry and in particular to develop a competitive greasy wool market that is attractive to both international and domestic wool buyers. Among the proposed measures are establishment of an independent wool testing facility, and wool sample system. * Programs to enhance quality, processing performance, and the environment. * Programs to develop the infrastructure of export markets in both FSU and Non-FSU countries, such as electronic links to markets. 151. The recommended actions are designed to create a more competitive market with a bias towards higher quality at all stages of production, distribution, and processing. At present greasy wool prices in the Republic appear to be at least 30 percent below world market prices. Realization of world parity wool prices involves a range of corrective programs to enhance the attractiveness of Kyrgyz wool. While removal of regulations and taxes and increased quality are necessary, they would not by themselves induce competition and give producers access to world prices. Of equal importance is the establishment of a viable greasy wool selling system so that producers can export greasy wool, as well as processed wool. This requires establishment of an independent wool testing facility, and a central handling system for taking samples and for commnunicating with buyers. There is substantial international trade in greasy wool, but in order for Kyrgyz producers to participate, they need wool selling regulations that protect the integrity of the product and security of both the buyer and seller. There may be an additional need to regulate the wool processing monopoly if it does not offer competitive prices. 152. Meat and meat byproducts can be sold on hard currency export markets only if standards throughout the industry are thoroughly reviewed, upgraded, and maintained. Control of disease (particularly brucellosis), should be improved, as should basic health and hygiene standards for both domestic and export markets. Modern profit-oriented management should be adopted at all stages. A higher standard of environmental control in disposal of waste products should be implemented. 153. Export markets are developing despite the formidable disincentives to export embodied until recently in local regulations. Removal of all export taxes and barriers to export, including export of live animals, is the first major task in rehabilitating the meat export industry. A second desirable reform is the provision of credit for the purchase of self- contained mobile abattoirs by private enterprises. These are an essential infrastructure requirement, since the unhygienic and dilapidated facilities currently used cannot be upgraded sufficiently in the short run to meet export requirements outside the former Soviet Union. The main purpose of mobile abattoirs is to enable herd and flock reduction over the next two to three years, and to allow the meat to be sold outside the former Soviet Union. After - 37 - completion of the herd drawdown, exports can be maintained through processing of domestic meat and meat from neighboring countries if necessary in order to build up a reliable export volume of interest to major importers. Recommendations and Conclusions 154. A number of measures can be undertaken in the short run to facilitate agricultural recovery. These measures fall into the general categories of regulatory reform, structural reform, and investment. 155. Regulatory Reform. A number of regulations were changed in early 1994. The legal basis for state orders was abolished. Freedom to export after fulfillment of domestic supply agreements was confirmed by decree. Domestic supply agreements remain in effect, and should be replaced by the unrestricted freedom to market goods. If the state chooses to procure agricultural commodities, it should obtain full financing for the purchases, and designate a commercial agent or state enterprise to undertake competitive bidding on its behalf. Import licensing should be required only for health and safety reasons, such as for agricultural chemicals. The export tax on wheat, hides, skins, and live animals should be removed. Imports of food, fiber, and agricultural inputs should be without tariffs, or should have low uniform tariffs so that domestic processing industries can grow and modernize. 156. Structural Reform: The program of land reform and farm restructuring should be thoroughly reviewed and revised in 1995, and vigorously implemented thereafter. Definition of eligibility to participate in the land reform should be clarified early. Water rights and grazing rights should be specified during the process of land reform and farm restructuring. The Ministry of Agriculture and Food should provide greater leadership in implementing land reform and farm restructuring, in partnership with local committees on which participants are represented. A massive program of public information should be launched. Privatization of food processing and distribution should continue. Privatization should include the parastatal monopolies that provide agricultural inputs, as well as the conglomerates in marketing. 157. Finance: Credit subsidies should be phased out as deregulation of pricing and marketing is implemented. Loans should be collateralized by farm production using market prices, and loan applicants should present a business plan demonstrating cash flow adequate to repay the loan. A decision regarding the future Agroprom Bank (that is, whether to restructure the existing bank or form new institutions on its branch foundation) should be taken in 1994. The primary objective in consideration of the future of Agroprom Bank should be to address the very critical weakness in delivery of financial services in rural areas. 158. Water Policy: Water fees should finance most of the operating costs of the irrigation system, and water users' associations should be established as part of the farm reorganization. 159. The Role of Government: Within the Ministry of Agriculture and Food, a shift in emphasis and personnel from traditional administrative management of production to policy analysis, implementation of reform, and provision of technical and economic - 38 - information to producers would better serve the sector under current budgetary constraints. The functions of local governmental officials should be redefined to focus on provision of information and explicitly to preclude administrative interference in production or marketing. Farms should be removed from the administrative jurisdiction of local agricultural officials. 160. Investment: Key investments in animal health, processing of meat and wool, and information for producers will improve productivity, export prospects, and public health. These investments are described in the annex chapters of this report, and in companion documents describing the Bank's proposed lending program for Kyrgyz agriculture. 161. A number of specific technical recommendations for the crop and livestock sectors are presented in the technical anrixes.