Tajikistan Country Economic Update Spring 2017 Strong Growth with a Challenging Outlook Macroeconomics & Fiscal Management Global Practice TAJIKISTAN: Strong Growth with a Challenging Outlook Country Economic Update Spring 2017 Government Fiscal Year: January 1 – December 31 Currency Equivalents: Official Exchange Rate Effective as of March 31, 2017 Currency Unit = Tajikistan Somoni (TJS) US$1 = TJS 8.2293 Weights and Measures: Metric System Abbreviations and Acronyms ADB Asian Development Bank AREAER Annual Report on Exchange Arrangements and Exchange Restrictions BT Barqi Tojik CHP Combined Heat and Power DIF Deposit Insurance Fund DPF-1 Development Financing Framework EBRD European Bank for Reconstruction and Development EU European Union FDI Foreign Direct Investment FSMR Financial Stability Monitoring Report FSR Financial Stability Report FSSA Financial System Stability Assessment HPP Hydropower Plant IFC International Finance Corporation IFI International Financial Institution IMF International Monetary Fund L2TJK Listening to Tajikistan Survey MOF Ministry of Finance NBT National Bank of Tajikistan NPL Non-Performing Loans PFMMP Public Finance Management Modernization Project PIP Public Investment Project SOE State-Owned-Enterprise TajStat Tajik Statistical Agency TSA Targeted Social Assistance WBG World Bank Group ii| Table of Contents Foreword ..................................................................................................................................................................................... v Overview ..................................................................................................................................................................................... 1 A. Recent Socio-Economic Developments ................................................................................................................ 2 Recent Political Events ......................................................................................................................... 2 Economic Growth and Inflation ............................................................................................................ 3 External Sector ...................................................................................................................................... 4 Social Sector ......................................................................................................................................... 7 B. Macroeconomic Policies and Structural Reforms ............................................................................................ 9 Assessment of Fiscal and Debt Policies ................................................................................................ 9 Assessment of Monetary and Exchange Rate Policies........................................................................ 11 Ongoing Structural Reforms ............................................................................................................... 13 C. Economic Outlook and Risks................................................................................................................................... 15 Baseline Scenario ................................................................................................................................ 15 Risks .................................................................................................................................................... 16 D. Focus Section: The Financial Sector Crisis ........................................................................................................ 17 Financial Sector Overview .................................................................................................................. 17 Developments...................................................................................................................................... 18 Reforms at the National Bank of Tajikistan ........................................................................................ 19 World Bank Group Activities in the Financial Sector ........................................................................ 19 Annex 1. Selected Macroeconomic and Social Indicators, 2014-2019 ............................................................ 21 Figures Figure 1: Growth Financing Sources ............................................................................................................................... 3 Figure 2: Sector Value Added to Growth.......................................................................................................................... 3 Figure 3: Consumer Price Inflation .................................................................................................................................. 4 Figure 4: Current Account Developments ..................................................................................................................... 5 Figure 5: Current Account Components......................................................................................................................... 5 Figure 6: Share of FDI by Sector, 2016 ........................................................................................................................... 5 Figure 7: International Reserves ....................................................................................................................................... 5 Figure 8: Average Wage by Key Sector ........................................................................................................................... 7 Figure 9: Poverty distribution in 2016 ........................................................................................................................... 8 Figure 10: Share of Food in Total Consumption ......................................................................................................... 8 Figure 11: Public Debt Composition ................................................................................................................................ 9 Figure 12: Money Supply Growth ................................................................................................................................... 12 Figure 13: Real Effective Exchange Rate Index ......................................................................................................... 12 Figure 14: Poverty Rate Projection ................................................................................................................................ 16 Figure 15: Financial Intermediation .............................................................................................................................. 17 Figure 16: Capital and Non-Performing Loans.......................................................................................................... 18 |iii Tables Table 1: Contribution to Real GDP Growth, 2013-2016 .......................................................................................... 4 Table 2: Balance of Payments and Official Reserves, 2013-2016........................................................................ 6 Table 3: Consolidated Fiscal Accounts, 2013-2016................................................................................................. 11 Table 4: Baseline Scenario: Selected Macro-Fiscal Indicators, 2016-19 ........................................................ 16 iv| Foreword This edition of the Tajikistan’s Country Economic Update (CEU) is part of a semi-annual series designed to monitor socio-economic developments in Tajikistan. It presents an analysis of political, economic and social developments, as well as the progress of and challenges with the implementation of structural reforms during 2016. It also includes a special section highlighting developments leading to the financial sector crisis. This edition’s main authors are Bakhrom Ziyaev (Economist for Tajikistan) and Zarina Odinaeva (Senior Financial Sector Specialist). The CEU benefited from the valuable inputs provided by Alisher Rajabov (Poverty Economist), Anvar Ibragimov (Private Sector Consultant), Hasan Aliev (Public Sector Specialist), Madina Nurmatova (Private Sector Specialist), Naoko Kojo (Senior Economist), Nigina Alieva (Communications Officer), Sabrina Qandenova (Health Consultant) and Takhmina Mukhamedova (Energy Specialist). The authors are grateful for the guidance and comments provided by Jan-Peter Olters (Country Manager for Tajikistan) and Christos Kostopoulos (Lead Economist for Central Asia). Nasiba Saidova (Program Assistant in Dushanbe) and Sarah Nankya Babirye (Program Assistant in Washington, D.C.) provided administrative support. Nigina Alieva and Navruza Aliqulova helped with report dissemination. María De los Angeles González-Miranda Practice Manager Macroeconomics and Fiscal Management Global Practice |v Overview Tajikistan’s Despite continuing external challenges, economic output rose strongly in economic growth 2016 according to official estimates. Driven mainly by foreign-financed public accelerated in and private investment, real GDP expanded by a robust 6.9 percent. At the 2016, driving down same time, a protracted decline in real remittances and exchange rate poverty rates. depreciation in the context of an improving but still complex external environment led to a significant adjustment in the current account balance. Depressed trade activity resulted in a fiscal revenue shortfall, while the exchange rate depreciation contributed to a surge in non-performing loans (NPLs), reversing previous fiscal consolidation efforts and causing substantial disruption to the performance of the financial sector. On the upside, strong growth pushed down the poverty rate from 32 percent in 2015 to an estimated 30.3 percent by the third quarter of 2016, primarily driven by an increase in wage incomes. The expansion of the Targeted Social Assistance (TSA) program helped to reduce extreme poverty. External The authorities pursued expansionary fiscal policies in 2016, including headwinds were through a considerable increase in foreign-financed capital investment in the countered by fiscal energy sector, road infrastructure and projects related to the country’s 25th stimulus and an anniversary of independence. The government also stimulated domestic accommodative demand by raising public sector wages and social transfers. The exchange monetary policy rate, although depreciating, stabilized throughout the year following the stance. introduction of administrative measures in February 2016. Monetary policy was accommodative, supporting a heightened demand for local currency as the exchange rate stabilized and wholesale transactions that were previously conducted in foreign currency switched to local currency. Domestic purchases of monetary gold and the introduction of a surrender requirement on ruble-denominated transfers drove an increase in international reserves. However, materialized risk in the financial sector and the subsequent bailout of Tajikistan’s two largest banks at end-2016 resulted in a deterioration of fiscal and debt sustainability indicators. Domestic Although the external environment is expected to recover, risks to growth are vulnerabilities put weighted to the downside owing to rising domestic vulnerabilities. Lingering the positive growth challenges in the financial sector, high state-owned enterprise (SOE) outlook at risk. contingent liability risk and an unconducive business climate weigh on economic growth prospects. Ongoing bank asset quality reviews may reveal additional capitalization needs while contradictory objectives and inefficiencies in the tax administration may potentially erode the tax base and deter new investments. A weaker-than-expected recovery in regional economies or delays in the expansion of the TSA program could derail poverty reduction efforts. Continuing challenges in accessing credit by pro- poor sectors of the economy will diminish the pace of both poverty reduction and job creation in low-skilled sectors like construction and agriculture. |1 A. Recent Socio-Economic Developments Recent Political Events The president’s As is customary, following the annual address of the president, Emomali annual address Rahmon, the cabinet and other key entities were reshuffled in the beginning was followed by a of the year. The Dushanbe administration as well as several ministries— cabinet reshuffle. including finance, transport and health and social protection—and the State Committee for State Property Management, among others, were all realigned. The speech focused In his annual address, President Rahmon emphasized the need to support on challenges in domestic private sector development and entrepreneurship, especially given the private and ongoing external economic challenges. He called on the National Bank of banking sectors. Tajikistan (NBT, the central bank) and the finance ministry to strengthen banking sector oversight and to undertake urgent measures to protect depositors’ rights. A new diplomatic The government is re-engaging with Uzbekistan following 25 years of relationship with diplomatic and economic tension. Uzbekistan's foreign affairs minister met Uzbekistan is with President Rahmon in Dushanbe in September 2016 and conveyed his anticipated. country's willingness to "reset" relations with Tajikistan, including by boosting trade and restoring direct flights between the two countries. As a result, the first direct flight since 1992 between Tajikistan and Uzbekistan took place on February 10, 2017. The Russian The president of the Russian Federation, Vladimir Putin, visited Dushanbe president’s visit to on February 27-28, 2017, on the occasion of the 25th anniversary of the Tajikistan establishment of diplomatic relations between Russia and Tajikistan. A reaffirmed strong number of cooperation documents were signed, including an agreement on bilateral ties. the use of nuclear energy for peaceful purposes and a revision of a ban on travel to Russia by Tajik citizens accused of violating migration regulations. As many as 200,000 Tajik laborers have been affected by the travel ban; under the revision, waivers may be granted to those who committed minor violations. During the visit, Russian officials also expressed their readiness to support increased agricultural exports from Tajikistan to Russia, including through subsidizing the railway transportation of goods. 2| Economic Growth and Inflation GDP growth Annual real GDP growth accelerated to 6.9 percent in 2016 from 6.0 percent accelerated in in 2015, according to official estimates. High levels of foreign-financed public 2016, supported and private investment—and an improvement in Tajikistan’s net export by foreign- position—more than compensated for a decline in consumption (Figure 1). financed The latter was driven by a decline in household consumption, which was investment largely affected by a protracted currency depreciation in early 2016 and a further decline in migrant transfers by over 13 percent year on year in US dollar terms.1 Figure 1: Growth Financing Sources Figure 2: Sector Value Added to Growth (Annual percentage change) 8 55 8 50 6 6 % of GDP % of GDP 45 4 40 4 2 35 2 0 30 2012 2013 2014 2015 2016 0 FDI (LHS) 2014 2015 2016 Foreign-financed PIP (LHS) Remittances (RHS) Industry Agriculture Construction Services Sources: TajStat, MOF, NBT and World Bank staff calculations. Source: TajStat and World Bank staff calculations. Low growth in On the supply side, economic growth was driven by the construction and the services industry sectors, which recorded annual growth rates of 20.3 percent and sector was more 16.0 percent, respectively. Donor-supported public investment in the than offset by rehabilitation of hydropower plants and road infrastructure drove firm strong growth in the construction sector, while industrial output was supported by construction and strong foreign direct investment (FDI) in coal and gold mining and processing industrial as well as the food and textile industries. The economic contribution of output. agriculture to GDP was modest in 2016, with annual growth of 5.2 percent (Figure 2), largely reflecting enhanced efficiency gains and favorable weather conditions. Conversely, growth in the services sector slowed to 1.1 percent (from 2.4 percent in 2015) owing to weak foreign trade activity as imports contracted. 1According to broad definition published by Central Bank of Russia, in 2016 money transfers totaled US$1.9 billion compared to US$2.2 billion in 2015. |3 Table 1: Contribution to Real GDP Growth, 2013-2016 (In percentage points) 2013 2014 2015 2016 Real GDP growth 7.4 6.7 6.0 6.9 Agriculture 2.0 1.1 0.9 1.3 Construction 1.6 3.0 2.5 2.7 Industry 0.6 0.8 1.6 2.3 Services 3.1 1.9 1.1 0.5 Sources: TajStat and World Bank staff estimates. Domestic According to official Figure 3: Consumer Price Inflation inflationary estimates, annual Annual percentage change pressures were consumer price inflation offset by easing was relatively stable in 10 global energy 2016, averaging 5.9 percent 8 and food prices. compared to 5.8 percent in 2015 (Figure 3). The early 6 2016 currency 4 depreciation contributed to 2 a surge in non-food inflation, which rose to 8.2 0 percent in 2016 from 4.8 percent in 2015. Inflation in services climbed to 4.9 percent (from 3 percent in Food Non-food 2015), driven by a mid-year Headline Services increase in public sector wages and pensions and Sources: TajStat and World Bank staff estimates. utility tariff hikes in the fourth quarter. Food price inflation eased to 5 percent (down from 6.8 percent in 2015) thanks to benign global prices for grains, wheat flour and other staples. External Sector The exchange Tajikistan’s external position improved in 2016 largely as a result of rate adjustment contraction of consumer imports. The current-account deficit narrowed to 3.8 drove a percent of GDP from 6.4 percent in 2015 (Figure 4). With consumer purchasing power restrained by lower remittance inflows and currency reduction in the depreciation, import spending on goods fell by 8.9 percent year on year in in the external 2016 (Figure 5). Conversely, export earnings rose by 20.8 percent year on year deficit. as domestic prices became more competitive, supported by new production capacity gains, largely in the minerals sector. However, earnings from key export commodities such as primary aluminum and cotton fiber declined by 4 percent and 15.1 percent, respectively—the former due to price effect and the 4| latter due to a volume effect (cotton prices were 3.4 percent higher in 2016 than in 2015).2 Figure 4: Current Account Developments Figure 5: Current Account Components Percent of GDP -2 8 40 -4 7 TJS per USD % of GDP -6 6 0 -8 5 -40 -10 4 2010 2012 2014 2016 -80 2010 2012 2014 2016 Current account balance (LHS) Exports Imports Exchange rate, average (RHS) Primary income Secondary income Sources: NBT and World Bank staff calculations. Sources: NBT and World Bank staff calculations FDI inflows Inflows of FDI totaled 5 percent of GDP in 2016, down from 5.4 percent in concentrated on 2015. The industries attracting the bulk of FDI in 2016 were mining and the mining and manufacturing (Figure 6). Around three-fourths of FDI inflows (74 percent) manufacturing in 2016 came from China while other major sources were Russia (8.1 industries. percent) and Switzerland (6.2 percent). Figure 6: Share of FDI by Sector, 2016 Figure 7: International Reserves (Months of import cover) 3.0 Other, 2.5 11.6% Agricultu 2.0 Educatio re, 9.9% n, 5.7% 1.5 1.0 Manufactu… 0.5 Mining, 43.7% - Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Sep-14 Sep-15 Sep-16 Mar-14 Mar-15 Mar-16 Sources: NBT and World Bank staff calculations. Source: NBT 2 Presumably, gold exports were also robust but this figure was not disclosed to the public due to confidentiality concerns. |5 Despite the A relatively stable exchange rate environment and new surrender observed requirements introduced on ruble-denominated remittances facilitated an improvement, accumulation of official reserves in 2016. International reserves held by the external buffers National Bank of Tajikistan (NBT) rose by over 30 percent year on year in remain insufficient. 2016, reaching 2.7 months of import cover (Figure 7). However, despite this strong growth, reserve levels remained below the recommended threshold of 3 months of import cover. Moreover, the reserves basket is heavily dominated by gold, creating a concentration risk and raising exposure to global price volatility. Table 2: Balance of Payments and Official Reserves, 2013-2016 (In US$ millions) 2013 2014 2015 2016e Current account balance -659.2 -261.2 -506.2 -264.7 Merchandise trade -3,904.6 -3,001.1 -2,287.9 -1,912.8 Exports f.o.b. 573.3 526.8 572.0 691.2 Imports f.o.b. 4,478.0 3,527.9 2,859.9 2,604.1 Services -283.2 -305.8 -241.4 -137.6 Primary income 2,664.4 2,183.8 1,526.2 1,213.6 Compensation of employees (net) 2,716.0 2,289.0 1,629.5 1,307.2 Secondary income 864.2 862.0 496.9 572.2 Capital and financial account balance -57.3 -259.4 -329.9 -272.6 Capital Account 134.2 124.0 144.0 143.9 Foreign direct investment -125.5 -309.3 -426.1 -344.1 Portfolio investment 1.2 -1.8 -0.1 0.0 Financial derivatives 0.0 0.0 0.0 0.0 Other short-term investments -23.6 16.7 -66.7 -118.8 Change in Reserve Assets -43.5 -88.9 19.0 46.5 Errors and omissions 333.6 -246.2 -111.7 -295.6 Memorandum items: NBT Official Reserves (months of import cover) 1.2 1.4 1.7 2.7 Nominal GDP (US$ million) 8,506 9,242 7,857 6,922 Sources: Tajik authorities and World Bank staff estimates. Note: Based on the 6th edition of the IMF’s Balance of Payments and International Investment Position Manual (BPM6). 6| Social Sector Labor market The official Figure 8: Average Wage by Key Sector pressures are slowly unemployment rate Nominal somoni per month easing. remained low in 3500 2016, at 2.3 percent, 3000 and labor market 2500 pressure has been 2000 slowly easing as 1500 employment 1000 prospects improve in 500 migrant destinations. 0 The number of job 2011 2012 2013 2014 2015 2016 vacancies reached Agriculture, Hunting and Forestry Construction 9,200 in December Financial intermediary 2016, 26.5 percent Education higher than in the Source: TajStat. year-earlier period. Furthermore, the number of applicants per vacancy fell from 11 persons in December 2015 to 9.2 persons in December 2016, underscoring easing labor market pressures. The economy created almost 59,000 jobs in 2016, more than half of which were classified as permanent. The share of temporary and seasonal jobs was relatively stable, hovering between 22 and 23.5 percent. When the pre- and post-Russian recession periods are compared, a significant shift is observed regarding wage employment, with jobs in agriculture falling by 3.1 percentage points in 2016 compared with 2014. Conversely, the share of wage employment in education and the health sector (including other social services) rose by 1.8 percentage points and 1.1 percentage points, respectively, in 2016. Agriculture continues to dominate the labor market but remains the lowest-paid sector (Figure 8). In contrast, the highest-paid industries are financial services and construction. Weak remittance Although poverty reduction stalled during the first nine months of 2015, inflows slowed the according to the seasonally-adjusted national poverty measure, some progress pace of poverty was made by the end of the year. Furthermore, the Listening to Tajikistan reduction. (L2TJK) household survey showed that incomes began to rise steadily in 2016 owing to increases in remittance inflows in Tajik somoni (TJS) terms, income from agricultural activities and self-employment, civil service wages, and student and pensioner benefits. These factors helped to drive down the national poverty rate from 32 percent in 2014 to 30.3 percent in the third quarter of 2016, with the rate of extreme poverty falling to 14 percent. The L2TJK survey also monitors the share of migrants returning to Tajikistan. This ratio has remained relatively stable since the launch of the survey in May 2015 at about 2 percent; the periods with the lowest share of returning migrants were in May-June 2015 and April–August 2016, when the share of returning |7 migrants fell to between 0.7 and 1.5 percent. Households have also recently indicated that a higher share of labor migrants are employed (rising from 83 percent between May and October 2015 to 86 percent in the same period of 2016). According to data from the Ministry of Labor, Migration and Employment, in December 2016 there were 517,308 Tajik migrants in Russia, a decline of 7 percent year on year. The geographic Levels of industrialization and urbanization are important determinants ofthe distribution of the poverty situation in Tajikistan’s regions. The lowest number of poor poor remains highly households continue to be located in Dushanbe and Sogd, where most uneven. economic activity is concentrated (Figure 9). By contrast, the Gorno- Badakhshan Autonomous Oblast (GBAO), Khatlon and the Regions of Republican Subordination (RRP) persistently show poverty rates above the national average. In 2015-2016, the average poverty rate in rural areas was almost ten percentage points higher than that of urban areas. Although the seasonal nature of poverty is well known, it is important to note that the churning of poverty is unusually high in Tajikistan. In particular, it is striking that 48 percent of the population was poor during only some quarters of 2015; only 13 percent of the population was poor during the entire year. Figure 9: Poverty distribution in 2016 Figure 10: Share of Food in Total Consumption In percent In percent 40 80 75 30 70 65 20 60 55 10 0 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 Sources: TajStat and World Bank staff calculations. Source: World Bank staff calculations based on TajStat Household Budget Survey (HBS) Still-muted global Although its share has fallen steadily, food still accounts for more than 70 food prices percent of consumption for poor and vulnerable households (Figure 10). benefited poor Because a significant share of the food consumed in Tajikistan is imported, households. exchange rate volatility was a particular concern in 2015 and 2016. Higher prices for food imports could have been passed onto poor and vulnerable consumers, who would have been harmed disproportionally by rising food prices. However, this scenario did not materialize thanks to benign global prices for grains and wheat flour. Indeed, food and wheat flour price inflation ran below headline consumer price inflation in 2016. 8| B. Macroeconomic Policies and Structural Reforms Assessment of Fiscal and Debt Policies Overly-ambitious Tajikistan’s fiscal standing deteriorated due to lower-than-expected budget assumptions revenue, insufficient mid-year adjustments to expenditure and an increase set the stage for a in foreign-financed public investment programs (PIPs). Despite various widening fiscal efforts by the government to contain the deficit—including spending cuts deficit. and increased scrutiny of low-priority current and capital outlays and an increase in non-tax collections—the fiscal deficit more than doubled in 2016, to 4 percent of GDP (from 1.9 percent in 2015). When the cost of the financial sector bailout is included, the deficit rises to 10.1 percent of GDP. Revenue Overall revenue significantly underperformed across all major categories underperformed in 2016, reflecting weak foreign trade flows and depressed domestic while expenditure business activity. Gross tax collections undershot the budget target by 7.3 was driven by percent with significant shortfalls in external value-added tax (VAT), foreign-financed income/profit taxes and social contributions. The shortfall was partially public investments. offset by strong collections of non-tax revenue, which over-performed by 43.4 percent as a result of higher collections of fines and penalties on retroactive cameral audits. Higher PIP grants—which rose by 31.4 percent year on year—also helped to contain the budget deficit. Expenditure was largely driven by foreign-financed PIPs (in the energy, transport and social sectors), outlays related to projects commemorating the 25th anniversary of Tajikistan’s independence and increase in the minimum wage, public sector wages, pensions and other social transfers. Core social and strategic capital spending (including for the Rogun hydropower plant) was ring- fenced. The government also honored its commitment to expand the TSA program to cover 40 districts. The financial sector The level of total public and Figure 11: Public Debt Composition bailout increased publicly-guaranteed (PPG) debt Percent of GDP the state budget surged to 41.4 percent of GDP in 45 burden 2016, from 34.1 percent in 2015 35 (Figure 11). New debt obligations were largely the 25 result of domestic bond 15 issuances for the financial sector 5 bailout totaling 6.1 percent of GDP, also affected by the somoni -5 2013 2014 2015 2016 depreciation. Nonetheless, external debt continued to Public domestic debt comprise the bulk of the total Public external debt PPG debt stock at 32.4 percent Sources: MOF and World Bank staff calculations of GDP in 2016. The creditor profile is heavily biased towards China, which accounts for over half of the |9 total external debt stock. Obligations to international finance institutions (IFIs) represent around one-third of external debt. In line with the Medium-Term Debt Strategy 2015-2017, in 2016 the government contracted loans with a 35 percent grant element while keeping total external debt below 40 percent of GDP. Weak compliance With the exception of a US$20 million credit tranche from the Eurasian limited access to IFI Development Bank, Tajikistan did not receive budgetary support from IFIs budgetary support. in 2016. The World Bank, Asian Development Bank (ADB) and the European Union (EU) all suspended budgetary support disbursements to Tajikistan after policy milestones were missed and issues in the financial sector were deemed to have not been adequately resolved. The fiscal deficit was financed through a combination of new debt, monetization, the privatization of state assets and a drawdown of government deposits. Some progress was In recent years, the government has made seeking to address some of the made on addressing risks associated with the contingent liabilities of SOEs. These efforts SOE contingent continued in 2016 with the expansion of the dividend policy to incorporate liabilities. SOEs with state majority ownership and the adoption of a Fiscal Risk Management Strategy. The strategy proposes a well-structured risk management framework to identify, monitor and manage risks stemming from the quasi-fiscal activities of SOEs.3 3As of July 1, 2016, total outstanding balances on accounts payable of the largest 23 SOEs totaled 34.5 percent of GDP while accounts receivable totaled 6.9 percent of GDP. The national power utility, Barqi Tojik, continues to be the largest drain on the state budget, accounting for over 70 percent of total SOE liabilities. 10| Table 3: Consolidated Fiscal Accounts, 2013-2016 (In percent of GDP) 2013 2014 2015 2016e Revenue and grants 27.2 28.4 29.9 28.4 Tax revenue 21.1 22.8 22.0 20.6 Income and profit taxes 4.0 4.2 4.8 4.4 Payroll taxes 2.7 3.0 2.8 2.5 Property taxes 1.4 1.5 1.2 1.2 Taxes on goods and services 11.5 12.8 12.0 11.3 International trade and operations 1.4 1.3 1.1 1.2 taxes Non-tax revenue 3.6 4.0 5.0 5.3 of which extra-budgetary funds 1.7 1.6 2.1 2.5 Grants 2.5 1.5 3.0 2.5 of which PIP 2.0 1.5 2.1 2.5 Expenditure and net lending 27.7 28.4 31.8 38.5 Current expenditure 17.7 18.1 18.0 17.4 Capital expenditure and net lending 9.9 10.2 13.8 21.1 Overall fiscal balance (incl. PIP) -0.6 0.0 -1.9 -10.1 Overall fiscal balance (excl. PIP) 0.7 1.1 1.2 -6.5 Memorandum items Total public debt 30.4 27.9 34.1 41.4 Nominal GDP (TJS million) 45,605 48,402 54,471 40,525 Sources: Tajik authorities and World Bank staff estimates. Note: Excluding the financial sector bailout, the overall fiscal deficit in 2016 (including PIP) was 4 percent of GDP. Assessment of Monetary and Exchange Rate Policies Monetary policy The money supply grew rapidly in 2016 (Figure 12) owing to the kept inflation in introduction of surrender requirements on ruble remittances, domestic single digits. gold purchases, emergency liquidity support and a drawdown of government deposits. However, inflationary pressures were contained as a result of the de-dollarization of wholesale transactions formerly conducted in foreign exchange. Private sector credit continued to contract owing to banking sector instability and reduced business activity. Throughout 2016 and into 2017, the NBT tightened monetary policy by steadily raising the refinancing rate from 8 percent to 16 percent, reserve requirement rates for somoni and foreign exchange deposits from 1.5 percent and 7 percent to 3 percent and 9 percent, respectively, while also sharply stepping up sterilization. The liquidity support rate for emergency needs was also increased above the interbank rate by 200 basis points. |11 Figure 12: Money Supply Growth Figure 13: Real Effective Exchange Rate Index December 2009 index=100 70 125 50 120 115 30 110 10 105 -10 100 2010 2011 2012 2013 2014 2015 2016 95 Broad money 90 Reserve money Credit to private sector Sources: NBT and World Bank staff calculations Source: NBT. Note: Index value above 100 indicates appreciation. Exchange rates The protracted decline in remittances, coupled with weak export earnings at stabilized after the beginning of 2016, put significant pressure on exchange rates (Figure 13). the introduction The authorities responded in early 2016 by introducing several of administrative administrative measures including the closure of foreign exchange kiosks, the measures early introduction of a 50 percent surrender requirement and the mandatory in the year. conversion of ruble remittances into somoni. These measures helped exchange rates to stabilize and converge for different market segments. The authorities shored up this framework by strengthening legal penalties for the illicit use of foreign exchange and increasing prosecutions with the help of law enforcement agencies. In 2016 the somoni depreciated by 11.2 percent vis-à-vis the US dollar, resulting in a cumulative depreciation of 35 percent in 2015-2016. This effectively reversed the real appreciation of the somoni from earlier periods, led by a policy change that favored a greater exchange rate flexibility. According to NBT estimates, the somoni was undervalued in real terms by around 3 percent at end-2016. However, in response to liquidity injections associated with the financial sector bailout, exchange rate pressures rebounded at the beginning of 2017. Monetary and Monetary policy was maintained in 2016 in line with the authorities’ long- exchange rate term objective of price stability and the notional target of keeping inflation in policies have single digits (a goal achieved in recent years). The NBT introduced new remained monetary policy tools in early 2017 including linking certificate of deposit broadly in line auctions to the refinance rate, extending maturities by up to six months and with stated offering overnight repurchase agreements to more efficiently manage daily objectives. liquidity needs. Tajikistan has a managed float exchange rate regime. However, the IMF’s 2016 Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), classified the de-facto exchange rate regime in the residual category of “other managed arrangement.” Due to still- 12| high levels of dollarization, the exchange rate continues to serve as a benchmark for determining the direction of monetary policy. Ongoing Structural Reforms Energy sector The recently-adopted National Development Strategy-2030 prioritizes energy reforms remain at sector as one of the strategic goals in country’s economic development agenda. the forefront of the Ongoing energy sector reforms aim to achieve energy security, reduce the government’s winter energy deficit and improve the financial standing of Barqi Tojik (BT), agenda. Tajikistan’s vertically integrated national power utility.4 Within the energy sector strategy, the government has: • Initiated the rehabilitation of existing generation facilities, including: ✓ The Nurek hydropower plant (HPP), the mainstay of Tajikistan’s energy sector generating 70 percent of the country’s total annual energy demand. The financing for the first phase of the Nurek rehabilitation, which will cost an estimated US$350 million, was secured from the World Bank, the Asian Infrastructure Investment Bank and the Eurasian Development Bank. ✓ The Golovnaya and Kairakum HPPs. • Constructed or began construction of new generation facilities, including: ✓ The 3,600 megawatt (MW) Rogun HPP on the Vakhsh River, with the river diversion officially inaugurated by the President in October 2016. The first two units of the Rogun HPP are expected to start generating electricity by mid-2019. The government announced a TJS 530 million money issue in April 2017 to finance the construction of the Rogun HPP. ✓ Commissioned the 400 MW Dushanbe-2 Combined Heat and Power Plant (CHPP). • Strengthened the power transmission network by constructing the North-South 500 kilovolt (kV) transmission line and rehabilitating major substations. Initiated reforms aimed at improving the financial viability of the energy sector, including adopting the Power Sector Financial Recovery Plan in April 2017, which specifies comprehensive measures to improve BT’s financial standing. These include utilizing a cost-recovery electricity tariff methodology, gradually increasing tariffs, improving bill collection rates, improving the 4 BT has incurred losses for many years due to a combination of factors including below cost tariff recovery and poor collection rates from SOEs and agriculture pumping stations. |13 efficiency of inventory management and repaying short-term commercial loans from cost savings, among other measures to improve the company's financial and operational performance. Development partners including the World Bank, ADB and EBRD will continue to support the government with the implementation of energy sector reforms. Efforts to improve The government continued to implement reforms in 2016 to improve the the business business climate and encourage foreign investment. These included some regulatory actions to streamline the permitting system, business inspections and framework procedures for starting and operating a business. In June 2016 the Ministry of continued. Health and the Ministry of Transport launched pilot programs allowing the electronic filing of documents to obtain permits. In July 2016 the government introduced a new Inspection Law with a risk-based approach for business inspections to ensure compliance (in contrast to a previous focus on revealing inconsistencies and imposing fines). To ensure a unified approach and to coordinate the activities of the various inspection bodies, the government established a Coordination Council on Inspection. Moreover, the government continued its efforts to simplify business registration procedures by integrating the information technology services of relevant agencies— including the Tax Committee, TajStat and the State Insurance and Pension Fund—into a one-stop-shop mechanism. Public financial In March 2016 the government established the Appeal Council, a platform for management tax disputes, under the Tax Committee. Around 20 percent of cases were reforms are resolved in favor of taxpayers in its first year of operation. In mid-2016, the progressing, but government also began the second phase of its Public Financial Management face delays. Modernization Project (PFMMP-2). The scope of the project was expanded to include public procurement, state audit and public administration reforms. However, due to technical reasons and delays related to the selection of consulting firms, progress has been limited to the establishment of a new data processing center and the continued strengthening of the e-filing system. Health reforms are After more than a decade, in 2016 the government finally adopted a resolution progressing on per capita financing of primary health care service providers. The new extremely slowly. framework, adopted in early 2016, envisages the more equitable allocation of funds for primary health care service providers based on the size of the population they serve. However, the introduction of Compulsory Medical Insurance, which has faced delays since 2014 due economic challenges, was delayed again in 2016. The next review is expected in mid-2017. 14| C. Economic Outlook and Risks Baseline Scenario Domestic Tajikistan’s real GDP growth rate is projected to decelerate in 2017 before vulnerabilities gradually recovering in 2018-19. However, growth will remain below 2016 will weigh on levels in 2017-2019. Lingering challenges in the financial sector, growing economic growth vulnerabilities in SOEs and an unconducive business climate will weigh on prospects. the economy’s growth prospects. Conversely, a gradual recovery in regional economies, the projected rebound of remittances and the restoration of bank lending, subject to comprehensive reforms, are expected to boost consumption and services growth over the medium term. A prudent monetary policy stance and improved policy transmission mechanisms will support the objective of keeping inflation in single digits. The external With FDI and debt inflows more than offsetting the current-account deficit, position will the overall external position is projected to be positive in 2017. Although the remain current-account deficit will widen considerably in 2017—driven by a pickup vulnerable to in domestic demand—over the medium-term, the revival of remittances and exogenous moderate price improvements for the country’s principal export shocks. commodities—namely cotton and aluminum—should result in a slight reduction in the current-account deficit and boost fiscal revenue. To the extent that the macroeconomic management framework is enhanced to ensure prudence—and structural reforms to improve the business climate are sustained and accelerated—higher public and private inflows are expected to materialize. Foreign reserves are forecast to rise to above the benchmark minimum of three months of import cover. Fiscal adjustment The public sector outlook envisages that gradual fiscal consolidation efforts will ensure will help to ensure fiscal and debt sustainability. Driven by lower capital sustainability. spending and a modest expansion of the tax base, the fiscal deficit is forecast to narrow gradually. Core social spending—including transfers to the most vulnerable—are expected to be safeguarded. However, public debt is projected to rise as a result of the costs associated with the financial sector bailout and new PIP-related external borrowing. |15 Poverty The poverty rate is projected Figure 14: Poverty Rate Projection reduction will to fall steadily (Figure 14), but Percent hinge on this will depend heavily on 30 remittances and economic recovery in Russia domestic wage and domestic income growth. income growth. More favorable migration 20 regulations will prop up outbound migration, 10 supporting income growth for the most vulnerable 0 2014 2015 2016e 2017f 2018f 2019f households. The new Law on Social Assistance and the Sources: TajStat and World Bank staff calculations. expansion of the TSA program Note: National poverty line in 2015 was TJS 167.76 per month. are expected to assist in a further reduction of extreme poverty. The poverty rate is projected to fall from 31.3 percent in 2015 to 26.1 percent by 2018. Table 4: Baseline Scenario: Selected Macro-Fiscal Indicators, 2016-19 (In percent, unless otherwise indicated) 2016e 2017f 2018f 2019f Real GDP growth 6.9 5.5 5.9 6.1 Private consumption -4.1 1.5 3.0 3.5 Government consumption 2.4 3.5 3.8 4.3 Gross fixed investments 21.2 11.8 11.8 11.8 Exports, goods and services 7.7 4.2 5.0 5.2 Imports, goods and services -15.0 0.0 2.0 2.5 Consumer price inflation, period average 5.9 7.0 7.0 7.0 Current-account balance (percent of GDP) -3.8 -4.7 -4.5 -4.4 Overall fiscal balance (percent of GDP) 1/ -10.1 -6.5 -5.4 -1.5 Government debt (percent of GDP) 1/ 41.4 48.9 54.2 55.6 Source: Tajik authorities, and World Bank staff estimates and projections 1/Calculations include the financial sector bailout in 2016 (6 percent of GDP) and projected additional recapitalization in 2017 (4 percent of GDP) and 2018 (3.5 percent of GDP). Materialization of fiscal risks due to contingent liabilities of SOEs could increase these figures by an additional 8 percent of GDP over the medium term, but this is excluded from current calculations. Risks Risks to growth Despite an anticipated improvement in the external environment, risks to will remain economic growth remain to the downside. Substantial contingent liabilities weighted to the among SOEs and a weak business environment—particularly with regards to downside a tax administration still plagued by contradictory objectives and inefficiencies in its implementation—will continue to hinder broad-based growth and may intensify debt-related risks. Ongoing asset-quality reviews at commercial banks may reveal new capitalization needs and further raise fiscal costs. A weaker-than-expected recovery among regional economies or delays 16| in the expansion of the TSA program could slow progress on poverty reduction. Finally, a combination of credit constraints and slow employment growth in pro-poor sectors such as construction and agriculture will remain a serious challenge to the government’s poverty reduction efforts. D. Focus Section: The Financial Sector Crisis Financial Sector Overview Tajikistan’s small With an asset to GDP ratio of only 39 percent,5 Tajikistan’s financial sector financial sector is is relatively small compared to those of other regional economies. The undercapitalized banking industry represents almost 90 percent of total financial sector and heavily assets and comprises 16 commercial banks, including one fully state- concentrated. owned bank, two majority state-owned banks and six majority foreign- owned banks. The largest four banks account for more than 80 percent of total bank assets. The micro-finance sector is the second largest industry, represented by 34 micro-deposit organizations and 46 micro-lending organizations and funds. The size of the insurance and leasing sectors is small, while the capital market is limited to 91-day treasury bills and advisory services are virtually non-existent.6 Financial Largely as a result of its Figure 15: Financial Intermediation intermediation is troubled banking history Percent of GDP limited. and legacy of government 20 interference in operational 18 decisions—which have 16 distorted the effective 14 allocation of resources for 12 years—Tajikistan’s deposit 2012 2013 2014 2015 2016 and credit penetration rates are below those of Credit Deposit other regional economies. Sources: NBT and World Bank staff calculations. At end-2016, the ratio of bank deposits and credit to GDP stood at 16.9 percent and 18 percent, respectively (Figure 15)—significantly lower than the Kyrgyz Republic (23.4 percent and 20.4 percent) and Kazakhstan (39.7 percent and 28.1 percent). Although falling in recent years, interest rates remain high; deposit and lending rates stood at 16 percent and 25 percent, respectively, in local currency terms at end-2016. The interest rate margin was high (at over 9 percent), indicating low efficiency, limited competition and severe funding constraints. 5Calculations are based on December 2016 data and include recapitalization. 6In April 2017 Bank Eskhata issued the first corporate bonds in Tajikistan’s history in the amount of TJS 20 million. |17 Developments Banking sector The banking sector in Tajikistan has a long history of weak performance, issues were including a major collapse after independence, a largest bank resolution in evident even 2004 and its bailout in 2012. The first signs of the 2016 financial sector before the crisis were evident in 2013, when the NPL ratio suddenly doubled to 15.9 Russian crisis. percent, up from an average of 8 percent in 2010-2012. Risks related to poor lending practices, including directed lending and inadequate risk management were further magnified by shortcomings in corporate governance and low capitalization levels in key banks. The onset of recession in Russia in 2014-16 worsened the situation. A simultaneous fall in remittances depressed private consumption and squeezed profit margins in the domestic market. As a result, asset quality indicators deteriorated rapidly, with NPLs rising from 25 percent in 2014 to 54 percent by the end of 2016.7 The banking sector portfolio, characterized by high levels of unhedged foreign-exchange borrowers, suffered even more due to a sharp depreciation of the somoni (totaling more than 39 percent in 2014-2016). High NPLs eroded The banking system’s Figure 16: Capital and Non-Performing capital to below reported aggregate capital Loans the minimum Percent adequacy ratio almost threshold of 12 halved from 22.1 percent in 60 percent. 2013 to 11.5 percent at 50 end-2015 (Figure 16). The 40 failure of the banks to meet 30 both their prudential and 20 operational obligations 10 triggered the assignment of 0 2012 2013 2014 2015 2016 a temporary administrator by the regulator for CAR NPLs 30 days + Fononbank in January Source : NBT. 2016 and for Tajprombank and Tajiksodirotbank in May 2016. These temporary administrators were extended several times as decisions were made in late 2016 and early 2017 as to whether the banks would be recapitalized or liquidated.8 Following the recapitalization of two banks (Agroinvestbank and Tajiksodirotbank)—in the amount of 6.1 percent of GDP9—and with NBT’s new regulatory mandate to supplement reserves, the capital adequacy ratio rose sharply, to 15 percent at end-2016 (from 6 percent in September 2016). Although the liquidity injection from the bailout propped up liquidity indicators, its distribution across the system 7 The rise in NPLs also reflects the reclassification of loans following an NBT audit in 2016. 8 Despite severe problems, Agroinvestbank was treated with forbearance with no temporary administration being assigned. 9 At the end of 2016, the Ministry of Finance issued bonds totaling TJS 3.3 billion with a five-year maturity and a 2 percent yield. Bonds were issued against posted collateral and equity acquisition in recapitalized banks. 18| remains uneven due to weaknesses in the interbank market. Two smaller banks, Tajprombank and Fononbank, were ordered into liquidation procedures in February 2017. The Deposit Insurance Fund (DIF) announced sufficient funds to cover state-guaranteed deposits (equivalent to TJS 17,5000 per individual). Although major IFIs had warned for years about the key weaknesses and risks that precipitated the crisis, a weak supervisory framework and political sensitivities prevented the timely provision of corrective actions. Reforms at the National Bank of Tajikistan The NBT is Since May 2015 the NBT introduced a number of reforms to strengthen its strengthening its supervisory response and build new mechanisms for macro-prudential regulatory policy, financial stability, bank resolution and consumer protection. A new framework. management team is in place, and new staff members have been hired. The financial stability, risk management and consumer protection units have been established and the IMF, World Bank and EBRD are actively providing assistance to the authorities. World Bank Group Activities in the Financial Sector Ongoing support by the World Bank Group (WBG) to the financial sector in Tajikistan includes a wide array of subjects that fall into seven main categories: • Financial Stability. In line with the recommendations of the Financial System Stability Assessment (FSSA),10 in 2015 the NBT established a Financial Stability Department, and in 2016 it was strengthened by an internal Financial Stability Committee. In March 2016, the first Financial Stability Monitoring Report (FSMR) was issued; quarterly reports were prepared throughout the year. In March 2017, the first annual Financial Stability Report (FSR) was approved by NBT Board. The authorities have decided to establish an inter-ministerial committee on the financial stability to include the NBT, the DIF, the Ministry of Finance and the Ministry of Economic Development and Trade • Bank Resolution Framework. Draft legislation that introduces new instruments for crisis preparedness and rapid response is slated for government approval in the third quarter of 2017. • NPL Action Plan and Bank Stress-Tests. Regulations were revised for more transparent reporting and the establishment of funds for loan 10 The FSSA is a joint product of the IMF and World Bank. The most recent report was prepared in May 2015. |19 loss provisioning. Stress tests were conducted for all 16 banks in 2016. • Bank Resolution Plans. A model template was developed for contingency planning, but financing assistance may be needed from donors for further action. • Consumer Protection. A consumer protection strategy was finalized for expedited adoption in March 2017 and relevant department has become fully operational within the NBT structure. • Payment Systems. The new RTGS payment system is expected to be upgraded with new hardware and software in 2018. • Insurance Sector. A new insurance law was approved in July 2016 and supervision over the sector was sifted to the NBT to be operational since January 2018. Moreover, the International Finance Corporation (of the World Bank Group) has been implementing a series of projects in collaboration with other donors, particularly in: • Strengthening the credit reporting system; • Introducing a modern secured transaction system and on-line moveable collateral registry; • Developing responsible microfinance practices and drafting of a microfinance strategy; • Developing digital financial services and cashless operations; • Strengthening advisory services for agriculture sector access to finance. Despite significant progress, much remains to be done particularly with regards to the sustainability and regulatory measures discussed above. Based on ongoing consultations with the authorities, the WBG has identified five areas for further improvement: financial stability, supervision, consumer protection, insurance industry and deposit insurance fund. 20| Annex 1. Selected Macroeconomic and Social Indicators, 2014-2019 2014 2015 2016e 2017f 2018f 2019f Projections (Percent, unless otherwise indicated) National Income and Prices Real GDP growth 6.7 6.0 6.9 5.5 5.9 6.1 Private consumption growth 1.8 -12.3 -4.1 1.5 3.0 3.5 Gross fixed investment (% of GDP) 4.6 5.4 6.1 6.5 6.8 7.2 Consumer price inflation, period average 6.1 5.8 5.9 7.0 7.0 7.0 Average exchange rate (TJS/USD) 4.93 6.17 7.84 … … … (Percent of GDP, unless otherwise indicated) External Accounts Exports of goods and services 9.0 10.5 13.3 14.1 15.4 16.1 Imports of goods and services 44.8 42.7 43.0 44.7 47.1 49.2 Current-account balance -2.8 -6.4 -3.8 -4.7 -4.5 -4.4 Foreign direct investment, net 3.3 5.4 5.0 4.5 4.0 4.0 (Percent of GDP, unless otherwise indicated) Consolidated Fiscal Accounts Revenue and grants 28.4 29.9 28.4 30.1 28.8 28.1 Expenditure and net lending 28.4 31.8 38.5 36.5 34.2 29.6 Overall fiscal balance 1/ 0.0 -1.9 -10.1 -6.5 -5.4 -1.5 Primary fiscal balance 0.5 -1.1 -9.3 -5.7 -4.9 -1.1 Total public debt 1/ 27.9 34.1 41.4 48.9 54.2 55.6 (Percent, unless otherwise indicated) Monetary Accounts Broad money growth 7.1 18.7 37.1 … … … Reserve money growth 13.2 16.0 71.1 … … … Private sector credit growth 31.5 12.7 -4.9 … … … Refinance rate 5.5-8.0 8.0 8.0-11.0 … … … Social Indicators Population, total (millions) 8.3 8.5 8.6 8.8 9.0 9.2 Population growth (percent) 2.3 2.4 2.2 2.2 2.1 2.1 Unemployment rate (officially registered) 2.5 2.5 2.4 … … … Poverty rate, (TJS 167.7/month) 32 31.3 29.3 27.9 26.1 24.2 Inequality (Gini coefficient) 30.8 27.5 28.0 … … … Life expectancy (years) 69.6 69.4 … … … … Sources: Tajik authorities and World Bank staff estimates and projections. Notes: An ellipsis (…) indicates that data are not available. 1/ Calculations include the cost of the financial sector bailout in 2016 (6 percent of GDP) and projected additional recapitalization in 2017 (4 percent of GDP) and 2018 (3.5 percent of GDP). Fiscal risks stemming from SOE contingent liabilities may result in an additional 8 percent of GDP increase over the medium term (this is excluded from current calculations). |21 Tajikistan Country Economic Update | Spring 2017