77607 Tajikistan Policy Notes on Public Expenditures Policy Note No. 1 Government Expenditures: Size, Composition, and Trends Report No. 77607-TJ Tajikistan Policy Notes on Public Expenditures Policy Note No. 1 Government Expenditures: Size, Composition and Trends August 2013 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Tajikistan Policy Notes on Public Expenditures | August 2013 REPUBLIC OF TAJIKISTAN Government Fiscal Year: January–December Currency Equivalents (Exchange rate as of August 1, 2013) Currency Unit = Tajikistan Somoni USD 1.00 = TJS 4.7679 TJS 1.00 = USD 0.2097 Weights and Measures Metric System Abbreviations and Acronyms AIB Agroinvestbank NBT National Bank of Tajikistan BEEPS Business Environment and Enterprise Performance NHA National health accounts Survey BT Barki Tajik PEFA Public Expenditure and Financial Accountability framework CSIP Central State Investment Program PER Public Expenditure Review DB Doing Business Report PFM Public Financial Management EBRD European Bank for Reconstruction and Development PFMMP Public Financial Management Modernization Project ECA Europe and Central Asia PHC Primary health care GDP Gross domestic product PIP Public Investment Program GNI Gross national income PRSP Poverty Reduction Strategy Paper IMF International Monetary Fund SOE State-owned enterprise LiTS Life in Transition Survey TALCO Tajik Aluminum Company MDRI Multilateral Debt Relief Initiative TSA Treasury Single Account MoEDT Ministry of Economic Development and Trade VAT Value-added tax MoF Ministry of Finance WB World Bank MTEF Medium-Term Expenditure Framework Vice President Philippe Le Houérou Country Director Saroj Kumar Jha Country Manager Marsha M. Olive Sector Director Yvonne M. Tsikata Sector Manager Ivailo V. Izvorski Sector Coordinator Francisco Galrao Carneiro Task Team Leaders Marina Bakanova and Ilyas Sarsenov ii │  Policy Note No. 1: Government Expenditures: Size, Composition and Trends Contents Abbreviations and Acronyms ii Prefacevii 1. Main Messages 1 2. Macroeconomic Context 4 A. Living Standards Have Improved but the Quality of Public Service Delivery is a Concern 4 B. Prudent Macroeconomic Management and Support from Development Partners Helped Tajikistan to Withstand the Global Downturn and Supported Quick Recovery 5 C. Tajikistan Economy Remains Vulnerable to External Shocks 7 3. Overall fiscal stance, fiscal risks and public finance management issues  9 A. Fiscal Consolidation is on Track but Prudent Management is Needed to Weather Shocks 9 B. Quasi-Fiscal Activities of State-owned Enterprises and Public Financial Institutions May Undermine Fiscal Consolidation 10 C. Strengthening the Public Finance Management System is a Priority 12 4. Government Spending: Composition and Trends  14 A. Government Spending is Heavily-skewed Toward Capital Investments 14 B. The Domestically-financed Capital Budget is More Focused on Power Generation, While External Financing is More Focused on Transport Connectivity 16 C. Increase in Current Expenditures is Largely Driven by Increased Wage Bill and Transfers to Households 17 D. Increased Public Spending Has Yet to be Translated Into Better Opportunities For All 19 5. Budget Revenues and Tax Reform 21 A. Budget Revenues have Trended Higher 21 B. The Tax Regime is Considered to be Cumbersome and is a Key Obstacle for Private Sector Development 22 C. The New Tax Reform is aimed at Simplifying and Improving the Overall Tax System  23 6. Conclusions 25 Annexes26 Contents │  iii Tajikistan Policy Notes on Public Expenditures | August 2013 List of Figures Figure 1. Remittances Became a Key Driver of Economic Growth During the Last Decade 4 Figure 2. Income Growth Helped to Halve the Incidence of Poverty 4 Figure 3. The Overall Fiscal Picture is Driven Mainly by the External PIP Financing 9 Figure 4. Without the PIP Financing, The ‘Core’ Budget Balance is on a Fiscal Consolidation Track 9 Figure 5. The Quasi-fiscal Deficit in the Power Sector Has Been Narrowed 10 Figure 6. Inter-enterprise Arrears Reduced but Remain Large 10 Figure 7. Government Spending in Tajikistan is at Par with Most Low and Lower Middle Income Peers 14 Figure 8. Government Capital Spending Ratio is the Highest Among Income-comparator Countries 14 Figure 9. Lowered Public External Debt Created Additional Fiscal Space for Expenditure Expansion 15 Figure 10. Domestic Capital Spending Increased and Averaged of About 8 Percent of GDP in 2007–12 15 Figure 11. Government Investments Into The Energy Sector Have Increased Significantly 16 Figure 12. While the PIP Financing for Energy is on a Decline and is Leaned More to Road Construction 16 Figure 13. Evolution of PIP Structure (excl. loans from China) 17 Figure 14. Government Spending on Education is in Between its Low-income Comparators in the ECA 20 Figure 15. Government Spending on Healthcare is at the Very Bottom in The Region 20 Figure 16. Tax Rates are Considered as the Main Constraint to Business Growth 22 Figure 17. The Tax Burden as a Percent of Profits has Increased 22 List of Tables Table 1. Selected Economic Indicators, 2007–12 6 Table 2. Tax Arrears in the State-owned Enterprise Sector, 2008–12 12 Table 3. Consolidated Government Expenditures by Economic Classification, 2007–12 18 Table 4. Consolidated Government Outlays by Functions, 2007–12 19 Table 5. Government Revenues and Grants, 2007–12 21 iv │ Contents Policy Note No. 1: Government Expenditures: Size, Composition and Trends List of Boxes Box 1. Types of Quasi-Fiscal Activities 11 List of Annexes Annex 1. Central State Investment Program 26 Annex Table 1.1. Central Capital Investments Budget, 2013–15 26 Annex Table 1.2. Public Expenditures on the Rogun Hydropower Project, 2007–15 27 Annex Table 1.3. Receipt of Funds by the Rogun Open Joint Stock Company, 2010–12 27 Annex 2. Public Investment Program 28 Annex Table 2.1. Chinese Credits for Investment Projects by Sector, 2007–12 28 Annex 3. Progress in Implementing the 2005 PER Recommendations 30 Contents │  v Policy Note No. 1: Government Expenditures: Size, Composition and Trends Preface This policy note was prepared by a World Bank team comprising Marina Bakanova (TTL, ECSP1), Ilyas Sarsenov (co- TTL, ECSP1), Salman Zaidi (TTL in FY2012, SASEP), Francisco Galrao Carneiro (Lead Economist and Country Sector Coordinator, ECSP1), Zuhro Qurbonova (Economist, ECSP1), Hassan Aliev (Public Sector Specialist, ECSP4). Natalia Pisareva (Eurasian Development Bank) also worked with the Bank team. Takhmina Jumaeva, Tojinisso Khomidova, and Zakia Nekaien-Nowrouz provided support to the team. The peer reviewers were Chiara Bronchi (Lead Public Sector Specialist, AFTP5) and Ekaterina Vostroknutova (Senior Economist, LCSPE). The team benefited from the guidance and advice of Ivailo V. Izvorski (Sector Manager, ECSP1) and Marsha M. Olive (Country Manager, ECCTJ). This note also reflects comments from colleagues from the World Bank and the International Monetary Fund (IMF) made in internal presentations and informal discussions. This policy note is part of the World Bank’s Programmatic Public Expenditure Review (PER) work program for FY2012-2014. The PER consists of a series of fiscal policy notes, which aim at providing the Government of Tajikistan with recommendations to strengthen budgetary processes and analysis. In doing so, the series focus on addressing the following two questions: (i) Should the government continue to pursue the same fiscal policies that appear, at least prima facie, to have served the country well over the past decade? and (ii) What key changes, if any, should it implement to achieve its economic and social goals in a fiscally sustainable manner? The work is being carried out in close collaboration with a counterpart Government of Tajikistan team led by the Ministry of Finance, which includes staff from the Ministries of Education and Healthcare, the state-owned enterprise monitoring unit in the Ministry of Finance, and Barki Tajik. An initial consultation on the proposed scope of work was held with the Ministry of Finance in late 2011. This policy note, the first in the series, sets a stage for the further in-depth discussion of the issues, identified in the note, based on the analysis of trends and composition of public spending during the last six years. The Note is structured as follows. Section 2 begins with a brief review of macroeconomic context to provide the background for analysis of fiscal policy during the last six years and implications for fiscal policy going forward. Section 3 presents the overall fiscal picture and highlights the fiscal risks to be addressed to sustain the recent progress in fiscal consolidation. Sections 4 and 5 dig deeper in the composition and trends of expenditures and revenues, respectively. Section 6 provides brief conclusions. Preface │  vii Policy Note No. 1: Government Expenditures: Size, Composition and Trends 1. Main Messages Poverty reduction and fiscal consolidation are on track, thanks to robust growth and large inflows of remittances. At the same time, the country remains vulnerable to external shocks, while some domestic policies, including directed lending and soft budget constraints in the state-owned enterprise sector create substantial quasi-fiscal risks. The authorities should continuously review the level and composition of public spending and keep it aligned with their long-term strategy and the needs of Tajikistan’s population. Quality and affordability of key public services require significant improvement. The government needs to consider carefully any large-scale investment projects as they reduce the fiscal space for the other important expenditures, including on human capital. The government is invited to consider strengthening the quality of public investment and finance management to ensure that targeted outcomes are achieved with minimal inefficiencies. 1. Remittance-led growth helped to reduce poverty but increased the vulnerability of the economy and the government budget to external shocks. Over the past decade, Tajikistan’s annual economic growth of 8 percent on average was driven mainly by a high inflow of remittances which increased from 5 percent of GDP in 2002 to more than 47 percent in 2012. As a result, per capita gross domestic product more than doubled in real terms and poverty incidence was reduced by half during this period. While Tajikistan’s economy has performed well, the economy and public finances remain vulnerable to external shocks stemming from remittance inflows, as well as volatile imports of fuel and food, and interruptions in transit trade and gas supplies from Uzbekistan. 2. Fiscal consolidation is on track but further rebuilding of fiscal buffers is needed to weather possible shocks in the future. During the last six years, the overall fiscal deficit narrowed from 6.1 percent of GDP in 2007 to a surplus of 0.1 percent in 2012. The ‘core’ fiscal balance, i.e. the balance excluding externally-financed public investments, also improved from a deficit of 0.2 percent of GDP during the crisis to a surplus of 1.4 percent of GDP in 2012. The government should maintain the policy of rebuilding fiscal buffers, given high vulnerability of the economy to external shocks and increasing debt repayment obligations in the medium-term. 3. Quasi-fiscal activities and directed lending programs may undermine fiscal consolidation. The quasi- fiscal deficit in the power sector narrowed from 6 percent of GDP in 2007 to 1 percent in 2011. Tax arrears reduced to less than one percent of GDP in 2011–2012. Meanwhile, the net arrears of state-owned enterprises (SOEs) have risen sharply and, by the beginning of 2013 accounted for 18.5 percent of GDP for accounts payable and 7.4 percent on accounts receivable. The health of the fiscal stance is also undermined by the fragility of the financial sector and, in particular, by the government directed lending programs through commercial banks. Such lending distorts the market, misallocates credit, and undermines confidence and the credit culture. In 2012 alone, the costs of bail out of a failed bank accounted for about 2 percent of GDP, which is comparable to the health sector budget for the same year. Unless the government stops this practice, more costs may occur. 4. The government needs to strike a better balance between capital spending and core social and maintenance expenditures. Tajikistan’s government spending at 28.5 percent of GDP in 2011 was in the middle of the universe of low and lower middle-income countries worldwide, while capital spending at 14.4 percent 1. Main Messages │  1 Tajikistan Policy Notes on Public Expenditures | August 2013 of GDP was twice as high as the average for the same set of countries. Over the last six years, the domestically financed capital budget expanded toward the power generation sector, while external financing focused more on transport connectivity. Increased capital spending in the energy sector is directed mainly to the Rogun hydropower project (HPP), which accounts for one-third of total domestically-financed capital expenditures. The pressure from expenditures on social policies (especially, education, healthcare and social assistance programs) is large, as well as the maintenance needs. The government needs to consider carefully any large-scale investment projects as they reduce the fiscal space for the other important expenditures (including, on human capital). Activities on the Rogun HPP (and, hence the financing) must continue to be limited to maintenance of existing structures until the techno- economic assessment and environmental and social assessment studies are completed. 5. Tax reform is a high priority of the Government of Tajikistan and an important foundation for achieving the country’s development goals. Maximizing revenue collection and closing the tax gap are needed to provide fiscal space for investments in key public services and infrastructure to deliver poverty reduction and spur economic growth. The new Tax Code provides an important opportunity to simplify the tax system and make it more efficient and productive. Initial implementation of the tax reform may be accompanied by some revenue losses, which should be offset by the improved revenue collection and broadening of the tax base. This could be complemented with better expenditure prioritization and strengthening of the public finance management system. Currently, an initial experience of the Tax Code implementation is being studied by the government (at the request of the President) due to unintended consequences on micro-entrepreneurs. The abuse of the patent system of taxation by large firms hiding as micro-entrepreneurs requires the patent system to be as restricted as possible to really very small businesses. 6. The analysis in this note suggests the following recommendations for consideration by the authorities: yy Maintain macroeconomic stability and build fiscal buffers to increase the resilience of the economy and the government budget to external shocks. Going forward, the benefits of higher fiscal buffers should be carefully weighed against foregone investment opportunities. yy Properly assess and avoid fiscal risks stemming from quasi-fiscal activities of SOEs and government direct lending programs. yy Strengthen the public finance management system to improve the efficiency of use of scarce public resources and their effectiveness. yy Continuously review the level and composition of public spending and keep it aligned with their long-term strategy and the needs of Tajikistan population. yy Strengthen the links between investment and recurrent budgeting. Link domestically financed and externally financed investment programs. yy Carefully assess the viability of any large-scale investment projects. Focus on prioritization and efficiency of investments to create fiscal space for core social spending and maintenance needs. 2 │ 1. Main Messages Policy Note No. 1: Government Expenditures: Size, Composition and Trends yy Avoid spending on the construction of the Rogun HPP until the technical, economic, and social viability of the project is fully assessed. yy Continue tax reform aimed at improving tax policy and strengthening tax administration to allow the private sector to thrive. Establish a feedback loop with businesses to instantly monitor the impact of the tax reform on the private sector and introduce timely corrections to the extent it does not compromise the stability of the overall tax system under the new Tax Code. 1. Main Messages │  3 Tajikistan Policy Notes on Public Expenditures | August 2013 2. Macroeconomic Context A. Living Standards Have Improved but the Quality of Public Service Delivery is a Concern 7. Strong increases of inflows of remittances, macroeconomic stability, and progress in advancing structural reforms supported robust growth and substantial poverty reduction over the last decade. Gross domestic product (GDP) grew by 8 percent per year on average over the past decade and poverty declined from 96 percent in 1999 to 47 percent in 2009 and further to below 40 percent in 2012. The improvements in Tajikistan’s living standards were also supported by rising inflows of donor assistance, including from international financial institutions and higher prices for the country’s key exports—aluminum and cotton—supported by robust demand abroad. Net inflow of worker remittances increased almost 10-fold over the past decade, from about 5 percent of GDP in 2002 to more than 47 percent in 2012, with a temporary disruption during the recent economic crisis (Figure 1). As a result of the strong growth performance over the past decade, per capita income more than doubled in real terms and the incidence of poverty was cut in half during this period (Figure 2). Figure 1. Remittances Became a Key Driver of Figure 2. Income Growth Helped to Halve the Economic Growth During the Last Decade Incidence of Poverty Economic Growth and Workers’ Remittances Economic Growth and Poverty reduction percent change percent of GDP per capita GDP index (2001=100) poverty headcount ratio 12 50 250 96.0 100 45 10 40 200 83.7 72.4 80 35 8 30 150 68.1 53.5 60 6 25 46.7 20 100 40 4 37.0 15 10 50 27.7 20 2 5 0 0 0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 JJGDP growth, lhs ▬▬Workers’ remittances, rhs JJPer capita GDP index, lhs ▬▬Poverty headcount ratio at national poverty line ▬▬Poverty headcount ratio at PPP $2 a day, rhs Sources: Statistical Agency and National Bank of Tajikistan. Sources: Statistical Agency of Tajikistan; World Bank. 8. Several key non-income dimensions of living conditions also improved. Tajikistan is approaching universal enrollment in primary and lower secondary education, while enrollment for 14 year-olds increased from 88 percent in 2007 to 95 percent in 2009 and after. Despite the low income per capita, the country has one of the highest rates of life satisfaction in the Europe and Central Asia (ECA) region. According to the EBRD-World Bank Life in Transition Survey (LiTS) carried out across the ECA region in late 2010, over 75 percent of respondents in Tajikistan said that 4 │ 2. Macroeconomic Context Policy Note No. 1: Government Expenditures: Size, Composition and Trends the economic situation had improved since 2006 and 64 percent said that the political climate also got better.1 Almost 70 percent of households reported they live better today than in 2006, and almost 60 percent were satisfied with their financial situation. There was widespread optimism for future generations across all age and income groups, despite the fact that Tajikistan, with a per-capita gross national income (GNI) of $880 in 2012, remains the poorest country in the ECA region. 9. Notwithstanding the progress, access to essential public services and their quality requires significant improvement. A recent World Bank survey of 2000 households in the country’s five regions found inter alia that: (i) for electricity, while nearly all respondents were connected, over 80 percent nationwide experienced unscheduled outages; (ii) for education, satisfaction with quality is very low, with only one-third of urban households and 19 percent of rural households satisfied or fully satisfied; and (iii) for health, access to both ambulatory and in- patient hospital services was inadequate, averaging 36 percent and 29 percent nationwide respectively, with the quality of services rated very poorly. Only 16 percent of households were satisfied with ambulatory care and 19 percent with inpatient hospital services.2 B. Prudent Macroeconomic Management and Support from Development Partners Helped Tajikistan to Withstand the Global Downturn and Supported Quick Recovery 10. Tajikistan was adversely affected by the recent global economic crisis that resulted in a decline in remittances and a fall in exports of cotton and aluminum. Economic growth fell to 3.9 percent in 2009 from 7.9 percent in 2008, but was still better than most countries in Central Asia (Table 1). Inflows of remittances grew five-fold from 2004 to 2008, as one-fifths of the country’s total working-age population migrated to Russia to look for work, before declining from $2.3 billion in 2008 (45 percent of GDP) to $1.6 billion in 2009 (33 percent of GDP).3 Exports in 2009 dropped by almost 11 percent due to lower international prices for cotton and aluminum. The financial sector was also adversely affected by the crisis, with non-performing loans of the banking sector rising to a record 28 percent of total loans. The disruption of cargo deliveries due to border closures with Uzbekistan and large amounts of directed lending to the cotton sector added to financial sector difficulties, which in turn led to a fall in credit flows to the private sector. 11. The government adopted a fiscal stimulus plan in response to the crisis, helping mitigate its impact on domestic demand; timely support from development partners supported the government efforts. To protect critical social spending, the government increased public spending under its anti-crisis action plan and expanded employment opportunities through social programs such as a cash-for-work scheme and measures to facilitate 1 Glinskaya and Zaidi, Satisfaction with Life and Public Service Delivery in Tajikistan: Key Findings from the 2006 and 2010 EBRD-World Bank Life in Transition Surveys, World Bank (mimeo), November 2011. 2 Tajikistan: 2012 Development Forum, Presentation by the Development Coordination Council, December 11, 2012. 3 According to the 2010 LiTS, 58 percent of households declared they had been affected adversely by the crisis. International migration and remittances were one of the main transmission channels: one-third of respondents reported they were affected through a reduced inflow of remittances or the return home of household members who used to work abroad. 2. Macroeconomic Context │  5 Tajikistan Policy Notes on Public Expenditures | August 2013 Table 1. Selected Economic Indicators, 2007–12 percent of GDP, unless otherwise indicated 2007 2008 2009 2010 2011 2012 National accounts and prices Atlas GNI per capita (U.S. dollars) 470 700 750 810 870 880 Real GDP growth (percent change) 7.8 7.9 3.9 6.5 7.4 7.5 CPI inflation, Dec/Dec (percent) 19.7 11.8 5.0 9.8 9.3 6.4 External accounts Current account balance -11.2 -7.6 -5.9 -1.2 -4.7 -1.9 Balance on goods & services -48.1 -55.3 -39.3 -37.3 -49.3 -47.2 Exports of goods and services 20.7 16.8 15.2 15.3 17.9 17.9 Import of goods and services 68.8 72.1 54.5 52.6 67.2 65.1 Net workers’ remittances 40.1 45.6 32.6 36.2 40.3 44.3 Fiscal accounts/1 General government revenue and grants 21.2 21.8 22.8 23.5 25.4 25.1 Tax revenue 17.8 18.6 17.7 18.0 19.5 19.9 Non-tax revenue and extra-budgetary funds 2.3 2.2 2.7 3.3 3.6 3.8 Grants 1.0 1.0 2.3 2.2 2.3 1.5 Government expenditure and net lending 27.3 27.2 27.6 27.2 28.5 25.1 Current expenditure 11.8 11.6 13.1 13.8 14.0 13.8 Domestic capital expenditure and net lending 7.5 8.0 9.0 8.4 9.6 8.7 External Public Investment Program (PIP) 8.0 7.7 5.5 5.0 4.9 2.6 Overall fiscal balance (including the PIP) -6.1 -5.4 -4.8 -3.7 -3.1 0.1 Overall fiscal balance (excluding the PIP) 1.1 1.5 -0.1 -0.2 0.1 1.4 External Public Debt (stock) 30.2 26.7 35.8 34.4 32.6 28.6 Sources: World Development Indicators, Statistical Agency of Tajikistan, National Bank of Tajikistan, and Ministry of Finance of Tajikistan; estimates of the World Bank and the International Monetary Fund. 1/ 2012 estimates are based on preliminary data. entrepreneurship. Additionally, the government restrained nonessential current spending, including on operations and maintenance, but excluded essential nondiscretionary expenditures like wages and salaries, employer contributions and interest payments. On the revenue side, as part of the stimulus package, the value-added tax (VAT) rate was reduced from 20 percent to 18 percent, resulting in a loss of tax revenues—and an equivalent gain in household incomes—by 1 percentage point of GDP. To finance the emerging fiscal gap, development partners increased budget support by an equivalent of 1.3 percent of GDP in 2009, which helped the government to maintain public expenditures on education, health, and social protection and to mitigate the crisis impact on poverty and vulnerable groups of population. 12. The economy has recovered since the 2009 slowdown. Real GDP grew by 6.5 percent in 2010, 7.4 percent in 2011 and 7.5 percent in 2012. Economic activity in the post-crisis period has been spurred by the pickup in gross remittance inflows, which rebounded sharply in 2010 and continued to grow afterwards, reaching record high level of $3.6 billion or 47.4 percent of GDP in 20124. Larger inflows of remittances fueled domestic demand, driven by an increasing flow of migrants to Russia due to Russia’s economic recovery. This in turn contributed to strong growth in services, which accounted for more than one-third of total growth in 2012. Industrial production also performed 4 The inflow of remittances through the banking system in Tajikistan represents a mixture of remittances and export proceeds. According to estimates from the National Bank of Tajikistan (NBT), export proceeds may be up to 25–30 percent of total remittances. This adjustment implies that the stated volume of remittances from labor migrants is usually overestimated. 6 │ 2. Macroeconomic Context Policy Note No. 1: Government Expenditures: Size, Composition and Trends well, rising by 10.4 percent, mostly driven by processing and extractive industries. Strong agricultural output growth also contributed to growth, rising by 10.4 percent during the year, mainly boosted by crop production. C. Tajikistan Economy Remains Vulnerable to External Shocks 13. The main external risks for Tajikistan from a global slowdown are through declining remittances and exports. A slower than projected growth in Russia—where more than 90 percent of Tajik migrants are employed— would lower domestic demand and growth and adversely affect government revenues, leading to an increase in the projected fiscal deficit compared to the baseline scenario. A high concentration of exports in just a few commodities and markets makes the country extremely vulnerable to external demand and price shocks with adverse impact on internal and external balances. For Tajikistan, the elasticities of total merchandise exports with respect to foreign GDPs tend to be under 0.9, with the highest elasticity of Tajikistan exports estimated in respect to Russian growth.5 These results suggest, for example, that a 1 percent decline in the GDP of China and the EU 27 (or difference relative to a given benchmark level of GDP) would result in 0.87 percent decline in Tajikistan’s exports to China and the EU. Slowing Russian growth by 1 percentage point would result in a 0.96 percent reduction in Tajikistan exports to Russia. Thus, Tajikistan growth is very volatile to changes in the Russian economy, which, in turn, is vulnerable to changes in hydrocarbon prices. 14. On the imports side, the risks are coming from the potential hikes in fuel and food prices. High dependence on food and fuel imports has made Tajikistan extremely vulnerable to increasing global food and fuel prices exacerbated by customs duties on oil and oil products introduced by Russia in May 2010 (after establishment of a customs union with Belarus and Kazakhstan). A substantial hike in Russian customs duties on export of oil products added an estimated $75 million (1 percent of GDP) to Tajikistan’s import bill in 2012.6 On February 6, 2013, an intergovernmental agreement on cooperation in the supply of oil products from Russia to Tajikistan was signed. The agreement stipulates a duty-free supply of oil products within the agreed indicative annual balances.7 While tax exemption would release the pressure on the import bill, the vulnerability to oil price shock would remain. 15. Recurrent interruptions in transit trade through Uzbekistan and higher transportation charges also have adverse economic and fiscal impacts. In 2010 and 2011, frequent disruptions of transit cargo through Uzbekistan adversely impacted both government revenue receipts as well as the rest of the economy. Value-added tax receipts in Tajikistan account for over 40 percent of total tax revenues, and in turn are heavily dependent on duties levied on imports. The disruptions of imports also adversely affected other sectors of the economy—e.g., agriculture (supply of fertilizers and other inputs), industrial production (supply of critical inputs for aluminum production by TALCO, Tajikistan Aluminum Company), and the services sector (working capital of firms tied up in transit goods). The March 2011 increase in rail tariffs for transit cargo by Uzbekistan also pushed up the prices of food items and other products imported into Tajikistan. 5 Tajikistan trade brief: Evolving trade patterns and challenges in a changing global environment, June 15, 2012. 6 On February 24, 2012 Russia set its customs duty on all types of gasoline at $370 per ton (the Government Resolution #163). During 2012, Tajikistan imported 372 thousand tons of oil products, 55 percent of which came from Russia (down from 95 percent in 2010). 7 1 million tons of oil products for 2013, 70 percent of which is diesel fuel and gasoline. 2. Macroeconomic Context │  7 Tajikistan Policy Notes on Public Expenditures | August 2013 16. Additionally, an irregular gas supply from Uzbekistan adversely impacts operation and profitability of certain industries in Tajikistan, and, consequently, their tax payments. Given that there are no multi-year contracts between Tajikistan and Uzbekistan on gas supplies, every year starts with disputes over gas supply contract renewals which lead to disruptions in outputs of two main gas consumers, TALCO and Tajikcement, the largest cement plant in Tajikistan. This, in turn, adversely impacted the companies’ financial position and their contributions to the budget 8 │ 2. Macroeconomic Context Policy Note No. 1: Government Expenditures: Size, Composition and Trends 3. Overall fiscal stance, fiscal risks and public finance management issues A. Fiscal Consolidation is on Track but Prudent Management is Needed to Weather Shocks 17. The overall fiscal stance improved notably in the post-crisis period. The overall fiscal deficit dropped dramatically from 6.1 percent of GDP in 2007 to a surplus of 0.1 percent in 2012, on the back of higher revenues and lower (in relation to GDP) expenditures (Table 1). The fiscal consolidation largely reflected the pattern of capital investments from the externally financed Public Investment Program (PIP), which is being phased out gradually (Figure 3). Higher revenues created a fiscal space for the expansion of current and domestically financed capital expenditures (see detailed discussion in Section 4 below). Excluding the PIP, the overall fiscal balance so-called “core” balance) improved notably since the crisis period with a fiscal surplus reaching 1.4 percent of GDP in 2012, i.e., exceeded a pre-crisis level (Figure 4). Figure 3. The Overall Fiscal Picture is Driven Mainly Figure 4. Without the PIP Financing, The ‘Core’ by the External PIP Financing Budget Balance is on a Fiscal Consolidation Track Government Budget Deficit Government Expenditures and Revenues (excl. PIP financing) percent of GDP percent of GDP 8 30 6.1 6 5.3 5.4 25 4.8 3.7 4 3.1 3.1 20 2.1 2.2 2.4 2 1.8 15 1.3 0.4 1.3 1.0 0 10 0.1 0.2 -0.1 -0.1 -0.4 -0.9 -0.7 -1.1 -1.0 -2 -1.5 5 -2.1 -4 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 JJPIP loans ▬▬Overall deficit (-) ▬▬Core fiscal deficit (-) JJCapital spending financed by GoT JJCurrent spending ▬▬Total revenues and current grants Source: Ministry of Finance of Tajikistan. Source: Ministry of Finance of Tajikistan. 18. Prudent fiscal management is needed to weather possible shocks and meet current and future obligations. Although the fiscal consolidation is on track, it is the result of external factors rather than domestic policies. Despite the sizable improvement in the government fiscal position, government deposits in banks fell from 33 percent of budget revenues in 2007 to 13 percent in 2011–2012. Thus, the buffers are yet to be restored. At the same time, amortization of external debt had elevated from 0.4 percent of GDP per annum in 2008–2011 to 0.9 percent in 2012 and expected to be above one percent of GDP over the medium-term. Given limited fiscal buffers 3. Overall fiscal stance, fiscal risks and public finance management issues │ 9 Tajikistan Policy Notes on Public Expenditures | August 2013 and high external vulnerability, further fiscal consolidation may be needed. A new debt sustainability assessment (DSA) for Tajikistan underscores the need for fiscal prudence.8 As the resilience of the economy to external shocks will increase, going forward, the benefits of higher fiscal buffers should be carefully weighed against foregone investment opportunities. B. Quasi-Fiscal Activities of State-owned Enterprises and Public Financial Institutions May Undermine Fiscal Consolidation 19. On the domestic front, there are fiscal risks stemming from the quasi-fiscal activities of state owned enterprises and public financial institutions. According to the IMF’s Manual on Fiscal Transparency (2001) quasi-fiscal activities (QFAs) include all activities under the general direction of government undertaken by the central bank and/or public financial and non-financial public enterprises that are fiscal in nature. QFAs involve a net transfer of public resources to the private sector (households and enterprises) through non budget channels (see, Box 1 or the types of QFAs). 20. Below cost-recovery tariffs, high transmission and distribution losses and poor collections of billed energy contribute to systematic imbalances between revenues and expenditures in the power sector. These imbalances—usually referred as quasi-fiscal deficit (QFD)—narrowed from 5.8 percent of GDP in 2007 to 1 percent in 2011, owing to tariff increases and strong economic growth (Figure 5). The QFD is fully absorbed by Barki Tajik (BT) through under-spending on operation and maintenance, insufficient investments, higher debt burden as well Figure 5. The Quasi-fiscal Deficit in the Power Figure 6. Inter-enterprise Arrears Reduced but Sector Has Been Narrowed Remain Large Developments in the Quasi-Fiscal Deficit in the Power Sector Accounts payable and receivable millions of TJS/USD percent percent of GDP 800 6 35 700 30 5 600 25 4 500 20 400 3 15 300 2 10 200 1 5 100 0 0 0 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 JJQFD, USD JJQFD, Tsom ▬▬QFD as % of GDP JJBT accounts receivable JJBT accounts payable ▬▬Accounts payable, total ▬▬Accounts receivable, total Source: World Bank staff estimates. Source: World Bank staff estimates based on MoF data. 8 The DSA has been produced jointly by World Bank and IMF staff, in consultation with Asian Development Bank staff. It will be published as a part of the IMF Staff Report on 2013 Article IV Consultations (forthcoming). 10 │ 3. Overall fiscal stance, fiscal risks and public finance management issues Policy Note No. 1: Government Expenditures: Size, Composition and Trends as substantial increase in payables, including taxes. Between 2008 and 2012, BT’s accounts payables increased five-fold in nominal terms, reaching 3,493 million somoni (around $733 million). Almost all of the short-term debt ($507 million) is in the form of bank loans to finance the recurrent expenditures and the long-term debt ($226 million) is driven by the borrowing for capital investment projects. Box 1. Types of Quasi-Fiscal Activities Activities related to non-financial public enterprises • Mispricing:  The pricing of commercial activities below-market or cost recovery. • Provision of non-commercial services:  The delivery of social services that are provided, for example, free of charge or below cost recovery, without being reflected in the government’s budget. • Soft budget constraints:  The tolerance of arrears, leading to distortions in the allocation of resources. Arrears are tantamount to an implicit subsidy, lost revenue for the enterprise, and lost tax revenue to the budget. Arrears often result from a lack of a strong payment culture, including from budget entities, government departments and state-owned enterprises. • Barter and offset arrangements:  These arrangements reduce both revenue and costs (expenditures), making it difficult to calculate the precise magnitude of the quasi-fiscal activity. • Operating inefficiency:  Technical losses and unmetered/unbilled consumption (including from theft) arising from poor operating performance, and resulting in low-collection rates. Activities related to public financial institutions • Subsidized lending and rescue operations or bailouts:  This includes below-market and preferential lending rates, poorly secured and sub-par loans, and mispriced loan guarantees. Rescue operations of both financial and non-financial public enterprises should be conducted through the budget. • Under remunerated reserve requirements:  The central bank often does not remunerate, or pays lower- than-market interest rates on commercial bank reserve requirements. • Operations related to the exchange rate system:  These can include multiple exchange rates and subsidized exchange risk insurance. • Sterilization operations:  Operations to sterilize capital inflows and manage liquidity through open market operations can entail significant losses to the central bank. As these losses must ultimately be covered by the government they are considered a QFA, even though they do not entail a (direct) tax or subsidy element. Alternatively, operations that generate central bank profits would improve the fiscal situation when these are remitted to the budget. Source: Manual on Fiscal Transparency, IMF, 2001. 21. Soft budget constraints in the form of arrears persist, resulting in a low payment culture. Tax arrears of state-owned enterprises (SOEs) peaked at 358 million somoni (6 percent of government revenues) in 2010, before falling to around 248 million somoni in 2012 (3 percent of government revenues) (Table 2). BT alone accounted for more than the entire improvement in tax arrears observed during 2011—mainly due to a write off of tax arrears related to a multi-party arrears settlement involving BT, TALCO, and Sanktuda—but, nonetheless, still accounts for three-quarters of total tax arrears owed by all SOEs. Wage arrears reached 42.5 million somoni or $8.9 million in 2012, but are minor compared to tax arrears in the SOE sector. SOEs’ net arrears on accounts payable and receivable have risen sharply between 2008 and 2011 to 30.2 percent of GDP on accounts payable and to 14.1 percent on accounts receivable (Figure 6). An inter-enterprise arrears reduced sharply in 2012—driven mainly by improvements of BT—but remain large, an equivalent to 18.5 percent of GDP on accounts payable and to 7.4 percent on accounts receivable. 3. Overall fiscal stance, fiscal risks and public finance management issues │ 11 Tajikistan Policy Notes on Public Expenditures | August 2013 Table 2. Tax Arrears in the State-owned Enterprise Sector, 2008–12 millions of somoni, unless otherwise indicated State-Owned Enterprises 2008 2009 2010 2011 2012 Total 199 312 358 215 248 Barki Tajik 127 249 322 166 211.6 TALCO 42 35 9 17 4.1 Fuel Gas Supply Corporation 4 6 8 9 10.9 Tajik Rail Road 6 2 5 6 1.9 Tajik Telecom 4 3 1 6 4.6 All other SOEs 17 16 14 12 14.9 Tax arrears, in percent of GDP 1.1 1.5 1.4 0.7 0.7 Source: Ministry of Finance of Tajikistan. 22. The financial position of SOEs is weakened by the “voluntary” participation in non-commercial activities and donations. Non-commercial services include financing of construction and repair of housing for citizens affected by natural disasters (e.g., floods); buildings for power, judiciary, and emergency agencies; roads; cultural buildings; and events. Donations are made to shelter houses, to low income population, veterans, etc. According to the Ministry of Finance estimates,9 in 2011 alone these voluntary contributions accounted for 0.4 percent of GDP or over one-fifth of public health expenditures. A separate policy note under the PER will examine the fiscal implications of SOEs. 23. The health of the fiscal stance is also undermined by the fragility of the financial sector and, in particular, by the government directed lending programs through commercial banks. The continued practice of government-directed lending has resulted in the deterioration of the balance sheet of one large commercial bank—Agroinvestbank (AIB), which struggled to meet the minimum capital adequacy ratio, and led to government interventions.10 The government directed lending practice has contributed to the deterioration of the loan portfolio of the AIB. As a result, this bank was effectively driven into bankruptcy and eventually was bailed out by the government. The costs of bail out—at about 2 percent of GDP—an equivalent to the total health spending during the same year. In 2012, the government has committed to stop this practice. However, progress in the resolution of the AIB has been very slow to date. Moreover, there are signs of continued directed lending. Unless the government stops this practice, more costs may incur in the coming years. Directed lending to insiders distorts the market, misallocates credit, and undermines confidence in the banking sector and the credit culture. C. Strengthening the Public Finance Management System is a Priority 24. Following the government’s Public Finance Management Reform Strategy for 2009–2018, several important reforms are being implemented. A recently completed Public Expenditure and Financial Accountability (PEFA) assessment has revealed an overall improvement across most Performance Indicators, with slippage in 9 Fiscal Risk Assessment of State Owned Enterprises, Ministry of Finance of the Republic of Tajikistan, 2012. 10 In April 2012, the Ministry of Finance issued 700 million somoni in government securities ostensibly to help the AIB to meet the minimum capital adequacy ratio and to purchase its non-performing loans with a face value of 528 million somoni. 12 │ 3. Overall fiscal stance, fiscal risks and public finance management issues Policy Note No. 1: Government Expenditures: Size, Composition and Trends some areas and no change in rating for others compared with the 2007 PEFA assessment. The Treasury Single Account (TSA) became operational and will eventually capture all the public financial resources of the national and sub-national budgets, including resources of special funds of budget organizations.11 In 2011 an SOE monitoring unit was established and is designed to assess and monitor fiscal risks associated with large SOEs on a regular basis. 25. Yet, progress to date has been uneven. On the downside, the PEFA team identified some (but slow) progress in developing a fully operational Medium-Term Expenditure Framework (MTEF) and in implementing a performance budgeting system at the national level. There are plans to provide more autonomy to budget organizations by allowing them to reallocate funds within budget programs. The increased autonomy of budget organizations is supposed to be balanced by an effective system of internal control/audit that needs to shift an emphasis from investigations of irregular transactions to providing recommendations on improving management processes of budget organizations. A separate policy note will discuss in detail the challenges facing the Public Finance Management (PFM) system and the way forward. 11 Currently TSA covers only the Republican Budget and 5 local budgets. It is expected that all local budgets will be included in 2014. 3. Overall fiscal stance, fiscal risks and public finance management issues │ 13 Tajikistan Policy Notes on Public Expenditures | August 2013 4. Government Spending: Composition and Trends A. Government Spending is Heavily-skewed Toward Capital Investments 26. Relative to GDP, government spending in Tajikistan is on par with most countries with a similar level of per capita income, but is too heavily-skewed toward capital outlays. In 2011, government expenditures reached a peak and amounted to 28.5 percent of GDP, which was in the middle of a spending range comprising low and lower middle income peer-countries (Figure 7). Compared to its income peers (with GNI per capita up to $1,500 in 2011), the general government expenditures to GDP ratio in Tajikistan was much lower than in the Kyrgyz Republic (38 percent of GDP) but was higher that in many other low income countries, such as Cameroon, Sudan, Pakistan, Cambodia, Benin, and Haiti (19–22 percent of GDP), while Kenya, Mauritania, Senegal, Nigeria, India, and Papua New Guinea had a spending ratio similar to Tajikistan (28–29 percent of GDP). However, in sharp contrast to the comparison of aggregate levels of public expenditure, capital expenditures in Tajikistan were much higher than in the income-comparator countries (Figure 8). Tajikistan’s government capital spending at 14.4 percent of GDP in 2011 was higher than in all income-comparators listed above. Figure 7. Government Spending in Tajikistan is at Figure 8. Government Capital Spending Ratio is the Par with Most Low and Lower Middle Income Peers Highest Among Income-comparator Countries Total Government Expenditures in Low and Lower Middle Government Capital Expenditures in Low and Lower Middle Income Countries Income Countries expenditures in 2010/2011, percent of GDP expenditures in 2010/2011, percent of GDP 45 UKR 18 BTN 16 40 MDA TJK KGZ 14 MNG PNG 35 12 VNM BTN HTI VNM SEN LAO BOL UZB BOL 10 MRT KHM 30 KEN YEM NGA MAR KEN MNG PNG 8 GEO SEN IND GHA TJK GEO ARM MRT 25 ZMB GHA 6 BEN KGZ MAR NIC MDA ARM BEN LAO NIC CMR PRY HTI CIV PRY PHL 4 PAK IND KHM PAK CIV 20 SDN SDN UKR CMR 2 ZMB 15 0 0 500 1,000 1,500 2,000 2,500 3,000 3,500 0 500 1,000 1,500 2,000 2,500 3,000 3,500 GNI per capita in 2011, US$ GNI per capita in 2011, US$ Sources: World Bank and International Monetary Fund. Sources: World Bank and International Monetary Fund. 27. Given an additional fiscal space provided by a substantial reduction in government external debt, the government’s domestic capital expenditures doubled and were coupled with an inflow of foreign financing for budget investments. A debt-for-equity swap with Russia in 2004 and the Multilateral Debt Relief Initiative (MDRI) in 2006 significantly reduced the external debt burden of the government. As a result, Tajikistan’s external public debt decreased from over 100 percent of GDP in 2001 to about 34 percent in 2007–2012 (Figure 9). Consequently, domestic capital spending increased steadily, from an average of about 4 percent of GDP per year during 2000–2006 to 8 percent a year on average during 2007–2012 (Figure 10). At the same time, external development partners also 14 │ 4. Government Spending: Composition and Trends Policy Note No. 1: Government Expenditures: Size, Composition and Trends increased their lending portfolios in Tajikistan from 3 percent of GDP per year during 2000–2006 to 8 percent per year during 2007–2008 and 5 percent per year during 2009–2011. Externally-financed capital spending plunged to 2.6 percent of GDP in 2012—due to completion of earlier financed investment projects—leading to an overall drop in budget investments from 14.4 percent of GDP in 2011 to 10.9 percent in 2012. Figure 9. Lowered Public External Debt Created Figure 10. Domestic Capital Spending Increased Additional Fiscal Space for Expenditure Expansion and Averaged of About 8 Percent of GDP in 2007–12 Public and Publicly Guaranteed External Debt Government Capital Expenditures and PIP percent of GDP percent of GDP percent of total expenditures 120 18 70 16 100 60 14 50 80 12 10 40 60 8 30 40 6 20 4 20 10 2 0 0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 JJTotal public and publicly guaranteed external debt JJExternally financed, lhs JJDomestically financed, lhs ▬▬Share of total expenditures, rhs Source: International Monetary Fund. Source: Ministry of Finance of Tajikistan. 28. Capital spending of the public sector is financed from domestic and external sources. The most important sources of government capital spending are the Centralized State Investment Program (CSIP) (Annex 1) and the Public Investment Program (PIP) (Annex 2). The CSIP is financed by central and local government budgets,12 while the PIP is financed by development partners, combining loans and grants, and, when required, government counterpart funding. Repairs and maintenance and small capital expenditures are financed by the regular budgets of line agencies. Finally, local governments may also co-finance capital construction projects, if their fiscal space allows. 29. The government has made some progress in implementing earlier PER recommendations to improve the capital budgeting process  (Annex 3). Historically, the preparation of the PIP in Tajikistan was an ad hoc exercise, done outside the regular budget process for the scheduled meetings of the Donor Consultative Group. As highlighted in the 2005 PER, neither the external debt implications nor counterpart funding needs of the PIP were adequately factored into the regular budget process. Following the adoption of a public finance law in 2002, the government has gradually adopted a Medium-Term Expenditure Framework and moved toward integrating PIP preparation with the regular budget process. However, as highlighted in the 2012 PEFA, despite some progress to date, investment and recurrent budgeting still remain rather separate in the current system of budget preparation. Estimates of future recurrent costs are still not a part of the process of planning and selecting investment projects at the moment; and the domestically financed and the externally financed investment plans are still not linked.13 12 Three main budgets operate under the Treasury control system: (i) the Republican budget of the central government, (ii) sub-national/local budgets of the regional executive authorities, and (iii) the extra-budgetary organizations. 13 World Bank (2012). Tajikistan: Public Expenditure and Financial Accountability Assessment. 4. Government Spending: Composition and Trends │  15 Tajikistan Policy Notes on Public Expenditures | August 2013 B. The Domestically-financed Capital Budget is More Focused on Power Generation, While External Financing is More Focused on Transport Connectivity 30. The domestically-financed capital budget has expanded toward the power generation, while capital spending on social sectors was maintained at about 2 percent per year on average. During the past six years, financing of capital expenditures in Tajikistan has shifted from externally-funded PIP grants and loans to the domestically funded CSIP, largely reflecting an increased government emphasis on financing infrastructure projects in the energy sector (Figure 11). Government capital spending on the energy sector rose from 0.4 percent of GDP in 2007 to 2.8 percent on average in 2009–2012. The upward shift in domestically-financed capital spending happened during the crisis when the government allocated more budget resources for infrastructure projects in the energy sector and for housing and communal services, and also reallocated some funds from other sectors. Government capital spending on social sectors increased from 1.1 percent of GDP in 2007 to 1.9 percent in 2008, and has been steady at 2 percent of GDP per year on average in 2009–2012. The largest recipients of the increased funds were education and culture and sports, while the relative shares of health and social security and welfare capital expenditures remained unchanged and very limited during this period. 31. Increased capital spending in the energy sector is directed mainly to the Rogun hydropower project. The budget allocation for the Rogun project increased from 0.8 percent of GDP in 2008 to 2.7 percent a year on average during 2009–2012 (Figure 11). In addition to funds raised through the equity campaign in 2010, the government outlays on the project have mainly been accommodated by reducing other capital outlays, as described above. As a result, the share of government capital transfers to the Rogun project tripled from 11 percent of domestically- financed capital budget in 2008 to over 30 percent a year during 2009–2012. During 2012–2013, the government adjusted spending on Rogun downwards, as part of a consensus building initiative, involving external assessment of the project. The government cut transfers to Rogun by 30 percent ($62 million) for the period of the assessment. The Government needs to consider carefully any large-scale investment projects as they reduce the fiscal space Figure 11. Government Investments Into The Figure 12. While the PIP Financing for Energy is on Energy Sector Have Increased Significantly a Decline and is Leaned More to Road Construction CSIP Composition by Sector PIP Composition by Sector percent of GDP percent of GDP 10 10 9 8 8 7 6 6 5 4 4 3 2 2 1 0 0 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 JJSocial sectors JJEnergy JJHousing/communal JJPublic admin. JJOther JJTransport JJEnergy JJAgriculture JJSocial sectors JJHousing/communal JJPublic admin. Source: Ministry of Finance of Tajikistan. Source: Ministry of Finance of Tajikistan. 16 │ 4. Government Spending: Composition and Trends Policy Note No. 1: Government Expenditures: Size, Composition and Trends for the other important expenditures (including, in human capital). In addition to public safety considerations— activities on the Rogun HPP must continue to be limited to maintenance of the existing structures until the techno- economic assessment and environmental and social assessment studies are completed—spending on Rogun need to be considered from the fiscal and debt position of the country. 32. External financing focus has shifted toward Figure 13. Evolution of PIP Structure (excl. loans transport connectivity. In 2007, transport and from China) energy accounted for about 83 percent of total PIP PIP (excl. China loans) structure by sector financing or 6.6 percent of GDP, almost 90 percent out in percent of total 100 of which were loans from China (Figure 12 and Annex 90 2). The PIP financing for energy projects was on a 80 decline from 3 percent of GDP annually on average 70 during 2007–2009 to less than 1 percent a year during 60 2011–2012, mainly driven by the cessation of Chinese 50 financing of this sector), leaving PIP investments 40 30 mainly directed at transport, infrastructure, as well as 20 agriculture and social projects Excluding loans from 10 China, PIP financing structure has evolved towards 0 transport connectivity (over 40 percent of total in 2007 2008 2009 2010 2011 2012 JJTransport and communications JJFuel and energy 2012). Despite some reduction in relative share, JJAgriculture, forestry, fishing, hunting JJHealthcare energy and agriculture remain important sectors JJEducation JJHousing and communal services JJOther sectors Source: World Bank staff calculations based on MoF data. (accounting for about 30 percent of total in 2012), followed by projects in health and education (about 20 percent of total in 2012) (Figure 13). C. Increase in Current Expenditures is Largely Driven by Increased Wage Bill and Transfers to Households 33. Other salient features of the economic composition of government spending in Tajikistan include: yy Outlays on wages and salaries have been raised to 5.6 percent of GDP in 2012 but remain lower than in income- comparator countries. Although expenditure on the wage bill increased from 4.1 percent of GDP in 2007–2008 to 5.6 percent in 2012 (Table 3), Tajikistan’s public spending on this sub-category continues to be lower than in several income-comparator countries in the ECA region.14 In particular, salaries of budget workers in Tajikistan are still quite low, averaging less than $120 per month (in the education and health sectors, they are even lower), which causes high turnover in public sector employment and difficulties in retaining high-skills staff. 14 In 2011, public expenditures on wages and employer contributions were higher in the Kyrgyz Republic (9.9 percent of GDP), Moldova (9.4 percent), Kosovo (8.3 percent), but at a similar level in Armenia, Georgia, and Albania. 4. Government Spending: Composition and Trends │  17 Tajikistan Policy Notes on Public Expenditures | August 2013 Table 3. Consolidated Government Expenditures by Economic Classification, 2007–12 percent of GDP, unless otherwise indicated 2007 2008 2009 2010 2011 2012^ Expenditures and net lending (In millions of somoni) 3,495 4,824 5,687 6,713 8,562 9,071 Expenditures and net lending 27.3 27.2 27.6 27.2 28.5 25.1 Current expenditures 11.8 11.6 13.1 13.8 14.0 13.8 Government consumption 7.6 7.5 8.2 8.8 8.7 8.0 Wages and employer contributions 4.1 4.1 4.7 4.3 5.0 5.6 Purchase of goods and services 3.5 3.4 3.5 4.5 3.7 2.5 Interest payments 0.5 0.3 0.5 0.5 0.5 0.9 External 0.3 0.3 0.4 0.4 0.4 0.4 Domestic 0.2 0.0 0.1 0.1 0.1 0.5 Subsidies and current transfers 3.7 3.7 4.4 4.5 4.8 4.9 Transfers to households 3.4 3.4 4.1 4.2 4.4 4.5 Subsidies and other current transfers 0.3 0.3 0.4 0.3 0.4 0.4 Capital expenditures 15.4 15.2 13.7 13.2 14.4 11.3 Externally financed 8.0 7.7 5.5 5.0 4.9 2.6 Domestically financed, of which: 7.4 7.4 8.3 8.3 9.5 8.7 Transfers to Rogun 0.0 0.8 2.5 2.6 3.0 2.6 Net lending 0.1 0.5 0.7 0.1 0.1 0.0 Sources: Ministry of Finance of Tajikistan; World Bank staff calculations. ^ Preliminary data. With World Bank support, the government has developed a new salary grid for public sector employees and introduced it in all central government entities in 2012, with the aim of eventually extending it to cover all other government entities. The gradual introduction of much-needed increases in real wages will increase the overall public sector wage bill and recurrent expenditure needs. An important consideration in this regard will be the extent to which the government succeeds in containing the total size of the public sector work force. yy Transfers to households have risen by a one-third in real terms since 2007, mainly due to increased social transfers during the crisis, but individual allowances remain relatively low. Transfers to households increased from 3.4 percent of GDP per year during 2007–2008 to 4.2 percent in 2009–2010 and further to 4.5 percent in 2011–2012. The upward shift in transfers to households was implemented during the recent crisis when the government introduced social programs such as a cash-for-work scheme and measures to facilitate entrepreneurship. Pension adjustments, which are usually harmonized with increases in salaries in the public sector, also contributed to the upward shift in government spending on social transfers. There were material increases of about 10 percent (in real terms) in salaries and pensions implemented during 2011–2012 (effective from September 1 of each year). These increases led to higher current expenditures by almost 0.5 percentage points of GDP in 2011–2012. Nevertheless, now the average pension in Tajikistan is about $50 per month, which indicates that pensioners are still very much dependent on other members of their households. 18 │ 4. Government Spending: Composition and Trends Policy Note No. 1: Government Expenditures: Size, Composition and Trends D. Increased Public Spending Has Yet to be Translated Into Better Opportunities For All 34. By function, expenditures allocated to social sectors (education, health, social security and welfare, and culture and sports) increased the most over the past six years. The share of spending on social policies in total public expenditures went up from 31 percent in 2007 to over 44 percent in 2012 (Table 4). The growth was mainly due to material increases in pensions and salaries in the public sector. The education sector by far is the largest recipient of budgetary funds, followed by social security and welfare program (16 and 15 percent of total budget expenditures in 2012 correspondingly). At the same time, the system of social assistance is small, accounting for 0.2 percent of GDP (or slightly above 5 percent of total expenditures for social security and welfare) and subject to large targeting errors.15 A substantial increase in public spending on culture and sports (it doubled in relation to GDP and more than doubled as a share of total expenditures between 2007 and 2012) was due to the implementation of large infrastructure projects in the capital city of Dushanbe16 and several football stadiums in Dushanbe and in other regions. Table 4. Consolidated Government Outlays by Functions, 2007–12 percent of total expenditures, unless otherwise indicated 2007 2008 2009 2010 2011 2012^ Total expenditures (In millions of somoni) 3,485 4,731 5,538 6,677 8,543 9,067 Total expenditures 100.0 100.0 100.0 100.0 100.0 100.0 Government administration and national security 20.5 16.3 14.9 13.7 14.6 15.6 General public services 12.2 8.3 7.2 6.3 6.5 6.3 Defense 3.7 3.7 3.5 3.5 3.8 4.0 Public order and safety 4.5 4.3 4.2 3.9 4.3 5.3 Social sectors 31.2 34.4 38.0 38.6 37.3 44.5 Education 13.9 13.8 15.8 15.3 14.4 16.8 Healthcare 4.7 5.5 6.0 5.8 6.2 8.0 Social security and welfare 10.4 11.3 13.0 13.1 12.8 15.1 Culture and sports 2.2 3.8 3.2 4.5 3.9 4.6 Economic affairs 40.6 43.5 38.6 37.2 38.2 29.9 Fuel and energy sector, of which: 13.4 19.0 19.0 16.3 13.3 12.9 Transfers to Rogun 0.2 3.1 9.5 9.6 10.4 10.3 Transport and communications 15.1 12.8 7.9 10.0 12.2 6.6 Housing and communal services 6.6 5.9 6.2 6.3 7.9 6.5 Agriculture, forestry, fishery, and hunting 4.6 4.3 4.8 3.2 3.4 2.6 Industry and construction 0.8 1.0 0.4 0.7 1.0 1.0 Other economic activity and services 0.2 0.5 0.3 0.7 0.3 0.3 Expenditures not included in other categories /1 7.7 5.8 8.4 10.6 10.0 10.0 Sources: Ministry of Finance of Tajikistan; World Bank staff calculations. Note: 1/ Include interest payments and expenditures of extra-budgetary funds, as a breakdown by functions was not available. ^Preliminary data. 15 World Bank (2013). The Impact of Social Assistance on the Lives of the Poor in Tajikistan. http://www.mehnat.tj/index.php/ru/sotsialnoe- obsluzhivanie 16 This includes the construction of the National Library (2009–2011), the National Museum (2010–2011), and the National Theater (2012 onwards). Expenditures for construction of the Palace of Nations (2003–2010) were reflected in the general public services sector. 4. Government Spending: Composition and Trends │  19 Tajikistan Policy Notes on Public Expenditures | August 2013 35. Despite recent increases in government spending on education and healthcare, Tajik citizens in general perceive these sectors as underfinanced. LiTS data confirm that Tajik citizens assign high priority to public spending on social sectors. In late-2010, when asked which sector should be the first priority for extra government spending, 47 percent of Tajik respondents chose education as their top priority, followed by 24 percent who chose health, and 14 percent who picked “assisting the poor”. International comparison also reveals that these sectors and the health sector, in particular, may benefit from more government financing. Tajikistan’s government spending on education, excluding the PIP, at 4 percent of GDP in 2011 was in between the income-comparators with higher spending, Moldova: 8.4 percent and the Kyrgyz Republic: 7.1 percent, and comparators with lower spending, Albania: 3.1 percent, Armenia: 2.8 percent, and Georgia: 2.6 percent (Figure 14). At 1.7 percent of GDP, its spending on healthcare was the lowest among all countries in the ECA region (Figure 15). Two separate policy notes under the PER will review in depth public expenditures on health and education. Figure 14. Government Spending on Education is in Figure 15. Government Spending on Healthcare is Between its Low-income Comparators in the ECA at the Very Bottom in The Region Government Spending on Education Across the ECA Government Spending on Health Across the ECA Countries Countries in 2011 in 2011 percent of GDP percent of GDP 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 AZE MDZ KGZ EST SVN UKR LTU LVA HUN POL TUR BLR CZE MKD MNE SVK KOS KAZ HRV TJK RUS BGR SRB ROU ALB ARM GEO CZE SVN SVK HRV SRB MKD EST MDA MNE AZE HUN LTU POL BGR RUS ROU LVA BLR UKR KGZ ALB KOS KAZ TUR GEO ARM TJK Source: World Bank ECA Region fiscal database. Source: World Bank ECA Region fiscal database. 20 │ 4. Government Spending: Composition and Trends Policy Note No. 1: Government Expenditures: Size, Composition and Trends 5. Budget Revenues and Tax Reform A. Budget Revenues have Trended Higher 36. Larger proceeds from labor taxes, combined with larger non-tax revenues, boosted total revenues during the last six years. Total revenues, excluding grants, rose from 21 percent of GDP in 2007–2010 to over 23 percent in 2011–2012, mainly due to higher labor tax payments and non-tax revenues, including extra-budgetary funds (Table 5). Labor taxes (personal income tax and payroll contributions) were driven mainly by a change in the definition of a taxable base for these taxes.17 As a result, labor taxes contributed about 1 percentage point of GDP to the budget revenue expansion. Non-tax revenues have also expanded by 1 percent of GDP since 2007. In 2011, indirect taxes also rose substantially due to a sharp reduction in the VAT threshold, from 800,000 somoni to 200,000 somoni. This measure helped to raise VAT revenues to the 2007 level after a decline that resulted from Table 5. Government Revenues and Grants, 2007–12 percent of GDP, unless otherwise indicated 2007 2008 2009 2010 2011 2012 Overall revenues and grants (In millions of somoni) 2,711 3,865 4,696 5,798 7,634 9,090 Overall revenues and grants 21.2 21.8 22.8 23.5 25.4 25.1 Total revenues 20.1 20.8 20.4 21.2 23.1 23.6 Tax revenues 17.8 18.6 17.7 18.0 19.5 19.9 Income and profit taxes 2.4 2.6 3.0 3.2 3.3 3.6 Corporate income taxes 1.1 1.2 1.2 1.3 1.4 1.6 Personal income tax 1.3 1.4 1.8 1.8 1.9 2.0 Payroll taxes 2.0 2.0 2.4 2.3 2.6 2.6 Property taxes 1.4 1.5 1.6 1.5 1.5 1.4 Taxes on goods and services 10.2 10.6 9.1 9.2 10.2 10.2 Value-added taxes (VAT) 8.3 8.8 7.4 7.4 8.4 8.5 Excises 0.8 0.8 0.8 0.7 0.6 0.5 Other domestic taxes on goods and services 1.0 1.0 0.9 1.1 1.2 1.2 International trade and operations taxes 1.9 1.8 1.6 1.8 2.0 2.0 Sales taxes 0.8 0.7 0.7 0.9 0.9 0.9 Other external taxes on trade and transactions 1.0 1.2 1.0 0.9 1.1 1.1 Non-tax revenues and extra-budgetary funds 2.3 2.2 2.7 3.3 3.6 3.8 Non-tax revenues 1.0 0.8 1.0 1.3 1.7 1.8 Extra-budgetary funds 1.3 1.4 1.7 2.0 1.9 1.9 Grants 1.0 1.0 2.3 2.2 2.3 1.5 Current grants 0.3 0.1 1.5 0.7 0.5 0.3 Public investment program (PIP) grants 0.8 0.9 0.8 1.5 1.7 1.2 Sources: IMF, Ministry of Finance of Tajikistan; World Bank staff calculations. ^ Preliminary data. 17 To avoid potential tax revenue losses from underreporting of actual salaries paid by employers, the authorities decided to change the methodology for defining a taxable base for labor taxes. The new rules required all employers to apply the average monthly salary reported by the Statistical Agency of Tajikistan, instead of actual salaries reported by employers. Consequently, the aggregate wage bill has expanded since then. 5. Budget Revenues and Tax Reform │  21 Tajikistan Policy Notes on Public Expenditures | August 2013 a cut in the VAT rate from 20 percent to 18 percent in 2008 as a response to the global crisis. In addition, external grants—predominantly associated with the externally financed PIP—contributed to a sizeable increase in total revenues, including grants, of over 1.3 percentage points of GDP during 2007–2011. The grant component was downsized in the 2012 budget, which affected the revenue side of the budget that dropped from 25.4 percent of GDP in 2011 to 25.1 percent in 2012. B. The Tax Regime is Considered to be Cumbersome and is a Key Obstacle for Private Sector Development 37. Firms indicate that high tax rates are a key obstacle for private sector development. The majority of respondents in the 2008/2009 Business Environment and Enterprise Performance Survey (BEEPS)18 cited tax rates as the most serious constraint to doing business in Tajikistan (Figure 16). The complex tax regime includes a large number of nuisance taxes, as well as reported corrupt practices by tax officials, that raise compliance costs for taxpayers and undercut the business climate and private sector growth. The latest Doing Business (DB) report19 also shows that in Tajikistan the share of profits paid for tax purposes increased from 80 percent in 2005–2007 to 84.5 percent in 2011–2012 and now exceeds averages for low and lower middle-income countries (Figure 17). As a result, Tajikistan’s ranking in ‘Paying taxes’ deteriorated further from a rank of 170 in DB 2012 to 175 in DB 2013 (out of 185 countries). At the same time, there are tax privileges and exemptions for some favored industry sectors. Tajikistan faces substantial challenges in revenue collection because the Tax Committee has limited capacity to Figure 16. Tax Rates are Considered as the Main Figure 17. The Tax Burden as a Percent of Profits Constraint to Business Growth has Increased Percentage of firms indicating area as a serious obstacle Total Tax Rate percent of firms percent of profit before all taxes 100 100 90 80 80 70 60 50 60 40 30 40 20 10 0 20 Tax rates Electricity Skills and education Access to finance Corruption Tax admin. Customs regulations Crime, theft, disorder Access to land Transport Telecom. Courts Labor regulations Business licensing 0 DB 2008 DB 2013 JJTajikistan JJLow income JJLower middle income Source: BEEPS 2008. Source: Doing Business Reports 2008 and 2013. 18 The Business Environment and Enterprise Performance Survey (BEEPS) is a joint initiative of the European Bank for Reconstruction and Development and the World Bank. The latest BEEPS was conducted in 2008/2009 and country-level data were published in January 2010. The new round of BEEPS was recently completed but the data were when this Note was prepared. 19 Doing Business 2013: Smarter Regulations for Small and Medium-Size Enterprises, October 23, 2012. 22 │ 5. Budget Revenues and Tax Reform Policy Note No. 1: Government Expenditures: Size, Composition and Trends detect tax evasion and the Ministry of Finance is weak in tax policy analysis, forecasting and policy formulation. Recognizing these problems, the government developed and adopted a new tax code in 2012. C. The New Tax Reform is aimed at Simplifying and Improving the Overall Tax System 38. Tax reform is a high priority of the Government of Tajikistan and an important foundation for achieving the country development goals. Maximizing revenue collection and closing the tax gap20 are needed to provide fiscal space for investments in key public services and infrastructure to deliver poverty reduction and spur economic growth. This would require a strong public sector that effectively raises revenues and provides high quality public service. Tajikistan faces substantial challenges in revenue collection because of low capacity of the Tax Committee to detect tax evasion and weak capacity of the Ministry of Finance to do good quality tax policy analysis, forecasting and policy formulation. The World Bank Tax Administration Reform Project (TARP) is to support the reform of tax administration to become more efficient and effective in collecting revenue, enhance the level of voluntary compliance, and improve the quality of taxpayer services that would help reduce the compliance burden for taxpayers, thus improving business environment and competitiveness.21 39. The new Tax Code provides an important opportunity to simplify the tax system and make it more efficient and productive. A recently revised Tax Code became effective in 2013 and is expected to enhance incentives for the private sector to grow while reducing incentives for tax avoidance. The new Tax Code reduces the number of taxes from 21 to 13. This was achieved by merging some similar taxes into unified taxes.22 To make the business environment friendlier, (i) the VAT threshold was raised from 200,000 somoni to 500,000 somoni, (ii) corporate income taxes will be cut from the current statutory rates at 25 and 15 percent to 23 and 13 percent in 2017, and (iii) the road user tax will be phased out by 2017. The revisions also streamlined tax concessions, by exempting all imported technologies and equipment from VAT and customs duties. While the simplified tax rate for small businesses was increased from 4 percent to 5 percent, small businesses were exempted from paying VAT. In order to limit pressure on taxpayers, the personal income tax brackets were revised. In addition, the social tax levying methodology was simplified to prevent firms from moving to the informal sector. By lowering the threshold for the patent system, the Tax Code attempted to minimize the abuse of patent by larger firms hiding as small. Over time the patent system could be replaced by simplified presumptive system for micro-business. However, the reaction of different businesses on the changes varies: bigger business is generally positive while micro-enterprises (patent holders) have expressed their concerns that they may run out of business. Currently, at the request of the President, unintended consequences on micro-enterprises are being studied by the government. 20 Tax gap is defined as the difference between the amount of taxes the government should collect and the amount of taxes the government actually collects. 21 World Bank (2012). Tax Administration Reform Project (TARP), Project Appraisal Document. Report No.71924-TJ, October 2, 2012. 22 For instance, land taxes and real estate tax were merged into a single property tax, sales tax on primary aluminum and cotton fiber and tax on aluminum processing were merged into a single sales tax, royalty from water and tax on subsurface users were merged into a single tax on natural resources. 5. Budget Revenues and Tax Reform │  23 Tajikistan Policy Notes on Public Expenditures | August 2013 40. Initial implementation of the tax reform may cause some revenue losses, but these losses should be offset by improved revenue collection, broadening the tax base and continued efforts to rebuild fiscal buffers. Some experts are concerned over potential revenue loss and debt accumulation arising from implementation of the Tax Code, which is estimated as 1.7 percent of GDP per year in the medium-term.23 While these estimates may overstate potential losses, they point to the need to strengthen revenue collection (including by imposing a fiscal discipline on SOEs) and improve the business climate (including by reducing the compliance burden on taxpayers). At the same time, the government should be focusing on prioritization and rationalization of expenditures, rebuilding fiscal buffers, sufficient to meet debt service needs and, increasing the resilience of the economy to a number of domestic and external shocks. 23 Preliminary estimates by tax officials and some experts are that the elimination of retail sales tax may bring a loss of 2.3 percent of total revenue, the elimination of the regional average salary floor for labor taxes may bring a loss of 2 percent, and the increase in the VAT threshold may bring a loss of 2.5 percent. 24 │ 5. Budget Revenues and Tax Reform Policy Note No. 1: Government Expenditures: Size, Composition and Trends 6. Conclusions 41. The main conclusions of this Note are as follows: yy Fiscal consolidation is on track, but further building of fiscal buffers may be needed to weather possible shocks and meet debt service and debt repayment obligations in the future. yy Risks to the fiscal adjustment are both domestic (soft budget constraints in the state-owned enterprise sector and government directed lending programs) and external (overreliance on foreign aid and on transit of fuel and food imports through Uzbekistan). yy Certain elements of the public finance management system have improved, but the overall PFM reform is progressing slowly. yy While the size of the government is relatively small, it is too heavily skewed toward capital outlays. The follow up in-depth analysis of capital expenditures and efficiency of public investment management (to be conducted during the second phase of the programmatic PER) will allow to identify the areas, where the savings could be made. yy Public spending on social sectors has increased, but the quality and access to public services, including to health and education, require significant improvement. yy Tajikistan faces substantial challenges in revenue collection because Tax Committee has a limited capacity to detect tax evasion and the Ministry of Finance requires strengthening in tax policy analysis, forecasting and policy formulation. The World Bank TARP aims to support the government efforts in addressing these weaknesses. yy A recently revised Tax Code became effective in 2013 and is expected to enhance incentives for the private sector to grow while reducing incentives for tax avoidance. 6. Conclusions │  25 Tajikistan Policy Notes on Public Expenditures | August 2013 Annexes Annex 1. Central State Investment Program The CSIP is the government’s main investment policy instrument at the regional and sectoral level. The Ministry of Economic Development and Trade is the lead agency responsible for implementation of the CSIP in collaboration with other line ministries, agencies, and local governments. The latest investment plan covers the period of 2013–2015, and earmarks the lion’s share of the CSIP budget to the energy sector (56 percent of envisaged total CSIP outlays of 6.7 billion somoni, or $1.4 billion). Housing and communal services (16 percent) and education (10 percent) were the next two most important sectors (Annex Table 1.1). Annex Table 1.1. Central Capital Investments Budget, 2013–15 2013 2014 2015 Total 2013–2015 In millions of somoni percent Total/1 2,068 2,300 2,374 6,742 100.0 Gov. admin. and national security 108 96 85 289 4.3 Social sectors, of which: 511 397 410 1,318 19.5 Education 230 210 233 672 10.0 Healthcare 80 63 61 204 3.0 Culture and sports 191 112 103 406 6.0 Economic affairs, of which: 1,449 1,808 1,878 5,135 76.2 Energy 1,013 1,369 1,421 3,803 56.4 Housing and communal services 344 358 371 1,073 15.9 Transport 20 16 17 53 0.8 Other sectors 72 65 69 206 3.1 Source: Ministry of Economic Development and Trade of Tajikistan. Note: 1/ Does not include expenditures on Maintenance and repair and Extra-budgetary funds. 26 │ Annexes Policy Note No. 1: Government Expenditures: Size, Composition and Trends The Rogun Hydropower Project accounts for nearly one third of government capital budget. The government has earmarked 3.6 billion somoni ($710 million) under its investment plan for 2010–2012 for the rehabilitation of the Rogun project. As highlighted in its Memorandum of Economic and Financial Policies, within its overall macroeconomic program, the construction of this project to address Tajikistan’s energy deficit is one of the government’s main strategic priorities. Between 2007 and 2012, the government disbursed 3.1 billion somoni ($691 million) on rehabilitation of the project (Annex Table 1.2). The investment plan for 2013–2015 envisages additional transfers to Rogun of 3.6 billion somoni ($710 million), or about 28 percent of total government capital budget, including Maintenance and repair and Extra-budgetary funds’ investments. Annex Table 1.2. Public Expenditures on the Rogun Hydropower Project, 2007–15 2007 2008 2009 2010 2011 2012 2013 2014 2015 actual actual actual actual actual actual projection Budget allocation (In 6 146 526 641 888 937 943 1,290 1,350 millions of somoni) Budget allocation (In 2 43 127 146 176 197 193 252 254 millions of USD) In percent of GDP 0.0 0.8 2.5 2.6 3.0 2.6 2.3 2.7 2.5 In percent of govt. capital 0.6 11.1 30.8 31.5 31.1 31.3 26.2 29.8 26.0 investments Sources: Ministry of Finance of Tajikistan; World Bank staff calculations. The government has financed all Rogun expenditures to-date through the budget and other local sources. The government launched an equity campaign in 2010 to raise funds for the project. In response to concerns expressed by development partners about the adverse social and macroeconomic implications of this equity campaign, the government agreed to suspend this campaign the same year. However, 820 million somoni was raised through this campaign before it was stopped, and the government received an additional 197 million somoni in 2011 (Annex Table 1.3). Funds raised through the campaign have been deposited in the National Bank of Tajikistan and local banks. Annex Table 1.3. Receipt of Funds by the Rogun Open Joint Stock Company, 2010–12 2010 2011 2012 actual actual actual Total cash inflows (In millions of somoni) 1,461 1,085 939 Government (state budget) 641 888 937 Equity campaign, of which: 820 197 2 Population (shares) 568 0 0 Banks (shares) 41 197 0 Enterprises (shares) 186 0 0 Other non-bank entities (shares) 0 0 2 Donations 25 0 0 Source: Ministry of Finance of Tajikistan. Annexes │  27 Tajikistan Policy Notes on Public Expenditures | August 2013 Annex 2. Public Investment Program In the past five years, there has been a marked shift in PIP priorities from social and other sectors to transport and energy. This reflects a marked shift both in government priorities as articulated in its Poverty Reduction Strategy, as well as the rising importance of some development partners as the main sources of PIP financing. As of the beginning of 2013, Tajikistan’s PIP comprised 56 active projects with combined project commitments of $2 billion to be financed through a combination of credits (51 percent), grants (38 percent), and GoT contributions (11 percent). The breakdown of the sources of financing is as follows: yy $1 billion credits: China (56.7 percent of total PIP credits), ADB (13.5), Islamic DB (10.7), Saudi Fund (4.0), World Bank (3.2), Kuwait Fund (3.0), OFID (3.0), KfW (2.7), EBRD (1.8), Abu Dhabi Fund (1.5); yy $764 million grants: ADB (57.7 percent of PIP grants), World Bank (26.4), EBRD (4.5), Japan (4.5), KfW (3.5), IFAD (1.6), and JICA (1.8); yy $211 million government contribution. Bilateral credits from China have been a key source of financing for increased capital expenditures. During 2007–2012, Chinese credits for transport and energy exceeded $900 million (Annex Table 2.1). These credits have a 20-year maturity, with a 5–7–9 year grace period and 2 percent annual interest rate, implying a grant element of 40 percent. Annex Table 2.1. Chinese Credits for Investment Projects by Sector, 2007–12 2007 2008 2009 2010 2011 2012 2007–2012 Total (In millions of somoni) 747 953 620 476 630 112 3,538 Energy 359 532 414 192 - 8 1,504 Transport 388 421 207 285 630 104 2,035 Total (In millions of USD) 217 279 150 109 137 24 915 Total (In percent of GDP) 5.8 5.4 3.0 1.9 2.1 0.3 2.5 Source: Ministry of Finance of Tajikistan.  Recent projects financed through Chinese credits include: yy “North-South” Electricity Transmission Line: One of the largest public investment projects constructed during the past 5 years, this transmission line has helped connect the northern Soghd region to the national electricity grid. This region was earlier supplied electricity through the unified Central Asia electricity grid via Uzbekistan, whose decision in 2009 to withdraw from the Central Asia grid made completion of this project a national priority for the government. Despite that total initial value of the project was $281.3 million; of which more than $267.2 million was provided by long-term loan from China, some additional funds were transferred in the second half of 2009 under a new credit agreement for supplemental construction. The “North-South” transmission line was put into operation in November 2009. yy 220kV “Lolazor-Khatlon” Electricity Transmission Line: The “Lolazor-Khatlon” transmission line was put into operation in June 2008. This 90 km transmission line has helped connect the south region to the national electricity grid. Despite that total initial value of the project was $58.1 million; of which more than 28 │ Annexes Policy Note No. 1: Government Expenditures: Size, Composition and Trends $55.2 million was provided by China, additional funds were transferred in the second half of 2009 under a new credit agreement with China for supplemental construction. yy 220kV “Khujand-Ayni” Electricity Transmission Line: The project includes construction of “Ayni” and “Shakhristan” substations and transmission lines. It is expected that Khujand-Ayni power transmission line will connect the Zarafshon Valley to the country’s unified power system through the 500kV South-North power grid. Total value of the project is $36.9 million, $35.1 million out of which is Chinese loan. yy Construction of the unified power system/single power grid for north of Tajikistan: A new Sughd-500 substation will provide regular electricity supplies to the north of Tajikistan. Total value of the project is $27.9 million with $1.4 million of government’s share. It is expected that construction of the Sughd-500 substation will also promote implementation of the Central Asia South Asia Electricity Trade and Transmission Project (CASA 1000), which aims to establish the necessary transmission systems and trading infrastructure to enable a trade of surplus electricity from Tajikistan and Kyrgyzstan to Afghanistan and Pakistan. yy Reconstruction of Dushanbe-Khujand-Chanak Highway: This 350-kilometer road connects the capital Dushanbe with Ayni, Istaravshan, and Khujand in the northern Soghd region, and ends in the Tajikistan- Uzbekistan border at Chanak. The project also includes construction of 5 km tunnel under the Shahristan pass, building some bridges, drainage ditches, and anti-avalanche galleries. Reconstruction of this road has been financed by a Chinese Eximbank credit (total value of the project is $295.9 million). To help repay the loan and cover road maintenance expenses, the government converted the highway to a toll road in 2010 and allowed a private company, Innovative Road Solutions, to collect the toll. yy Dushanbe-Dangara Road: This 154 km road between Dushanbe, Vakhdat, and Dangara is the first phase of the 1,100 km Tajikistan-China highway planned eventually, completion of which is expected to significantly boost bilateral economic trade between the two countries. As of end-2011, 687 million somoni ($178 million) had been spent. The first phase of the project also includes construction of the 4.4 km tunnel “Chormagzak”. Annexes │  29 Tajikistan Policy Notes on Public Expenditures | August 2013 Annex 3. Progress in Implementing the 2005 PER Recommendations Recommendations Implementation Progress Make public capital The total (domestic and external) capital expenditure envelope has been integrated into the Medium- expenditure envelope, Term Expenditure Framework process. According to the MTEF budget calendar for 2012-2014, MoEDT including PIP, consistent had to submit its three-year investments plan to MoF on March 1, 2011, which was then taken by the with MTEF and debt latter as a base for determination capital expenditure envelope. During the MTEF drafting, MoEDT strategy. coordinated its work with MoF’s Debt Department to ensure public debt would not exceed the debt ceiling of 40 percent of GDP. Establish a multi-year The State Investments Program (SIP) is a rolling three-year planning tool for public investment rolling ceiling for new prepared by MoEDT. Since 2010, Tajikistan has had two SIPs covering 2011-2013 and 2012-2014. commitments to be made The SIP document includes projects with confirmed financing (agreements with donors are signed), under investment credits. projects with partial confirmation (projects are under negotiation), and new proposals for grants and technical assistance, which are opened for donor financing, and thus provides a framework for both the government and donors to identify the most important points of intervention during the forthcoming 3-year period. Present CSIP as a part of the Some major improvements have been made during the past years. In particular, starting from 2011 the broadly defined PIP, which, centralized state investment expenditures have been presented as a part of the broadly defined “The in turn, should be aligned State investments, grants and capital construction program” for a medium-term period. with the streamlined PRSP. Reduce number of projects The number of active PIP investments projects was 37 in 2007, and rose to about 51 in 2011. in PIP and CSIP Increase budget coverage 34 PIP projects out of 37 projects had internally financed contribution/government share in to include foreign financed 2007 which amounted to $24.1 million, while in 2011 only 32 projects out of 51 had government PIP. contribution with amount of $13.6 million. Develop methodological The Public Financial Management Modernization Project (PFMMP) has selected a consulting company guidelines to estimate that will help with developing methodologies for investment expenditure planning. This will include expected disbursement developing detailed functions, roles and legislation of improved approach for capital budgeting, new under ongoing projects. methodology for projects evaluation, and implementing and maintaining investment projects’ database. Perform a functional review The functional reviews of the MoF and MoEDT were conducted under PSRP in 2011. There is a of institutions involved in government decree requiring implementation of recommendations of functional reviews. preparation. Develop methodology PFMMP has selected a consulting company that will help with developing methodologies for investment for project evaluation expenditure planning. At present, MoEDT uses the following criteria according to Government Decree and selection, including as of August 1, 2011 (No. 370) : (1) Strategic consideration (whether proposed projects reflect economic analysis and risks the strategic national priorities indicated in PRSP, National Development Strategy, and Millennium assessment. Development Goals?); (2) Project formulation (Are submitted projects formulated in a proper way? Special attention is paid to the quality of submitted project during the selection process); (3) Economic substantiation (Are all costs and benefits entailed by the project calculated? Is there any document available to prove such calculation? Whether technical-economical substantiation/feasibility study is conducted? In addition, will the government take responsibility over the project, or responsibility will be taken by the private sector?) Under the circumstance of lack of substantiation, in many cases it was recommended to conduct a technical-economical substantiation; (4) Capacity for project implementation: (Does the implementing entity/agency possess capacity for project implementation? Is there necessary subsidiary infrastructure available? Is there a need to amend regulatory framework?) Implementation capacity is re-considered during the stage of doing technical-economical substantiation of projects, and (5) Environmental and social impacts (Is any environmental or social impact considered?) Investment projects must be developed in line with existing legislation with respect to protection of environment and ecological standards. 30 │ Annexes Policy Note No. 1: Government Expenditures: Size, Composition and Trends Make accounting and PFMMP has selected a consulting company that will help with developing methodologies for investment reporting on projects expenditure planning. Currently all PIP projects (foreign financed and co-financed by the government) consistent with the are integrated into a budget and are consistent with GFS 1986. However, PIP projects are integrated Government Finance into different budget accounts. Thus, Chinese loans are reported in economic budget classification Statistics (GFS) manual and code 5.1 “Capital expenditures”. All other PIP projects are reported in 2.1.17 budget code “Other budget classifications. expenditures”. Eliminate excessive and PFMMP has selected a consulting company that will help with developing methodologies for investment duplicative reporting. expenditure planning. Annexes │  31