Final Draft

ECONOMIC REPORT

AND

INTERIM OPERATIONAL STRATEGY

FOR

TURKMENISTAN

May 2002

ECONOMIC REPORT AND INTERIM OPERATIONAL STRATEGY FOR TURKMENISTAN*

CURRENCY EQUIVALENT

Currency Unit – Turkmen manat (Tmm) $1 = 5,200 manat (official rate) 1 manat = $0.0001923 $1 = 22,000 manat (market rate)

ABBREVIATIONS

ADB – Asian Development Bank CAR – Central Asian republic CBT – Central Bank of Turkmenistan CIS – Commonwealth of Independent States EBRD – European Bank for Reconstruction and Development FERF – Foreign Exchange Reserve Fund FSU – former Soviet Union FY – fiscal year GDP – Gross domestic product IDB – Islamic Development Bank IMF – International Monetary Fund IOS – Interim Operational Strategy MOHMI – Ministry of Health and Medical Industry SME – small and medium enterprise TA – technical assistance TACIS – Technical Assistance to Commonwealth of Independent States UNDP – United Nations Development Programme US – United States USAID – United States Agency for International Development

NOTES

(i) The fiscal year of the Government ending on 31 December. FY before a calendar year denotes the year in which the fiscal year ends.

(ii) In the report, “$” refers to US dollars.

* The report was prepared in the Operations Coordination Division of the East and Central Asia Department (formerly

Programs Division II in the Programs East Department) by a team comprising Rajiv Kumar, Putu Kamayana, and Valerie Reppelin-Hill. Substantial contributions were also made by Armin Bauer, Claudia Buentjen, Rudolph Frauendorfer, Xiaojing Ma, Richard Pomfret, and Joji Tokeshi.

CONTENTS Page

BASIC DATA ii EXECUTIVE SUMMARY iv MAP viii

I. COUNTRY BACKGROUND 1 A. Geography and Population ....................................................................................1 B. Administration and Political Setting .......................................................................1 C. Structure of the Economy ......................................................................................2 D. Data Issues............................................................................................................2

II. ECONOMIC DEVELOPMENT AND TRANSITION 3 A. Economic Development.........................................................................................3 B. Economic Reforms and Progress in Transition ...................................................13

III. DEVELOPMENT ISSUES 16 A. Economic Growth: Development of the Productive Sectors ................................16 B. Social Security and Social Development .............................................................22 C. Environmental Management................................................................................28 D. Public Sector Management..................................................................................29 E. Relations with International Organizations and External Assistance...................29

IV. INTERIM OPERATIONAL STRATEGY 32 A. Background and Approach ..................................................................................32 B. Overarching Goal and Strategic Objectives.........................................................33 C. Cross-Cutting Dimensions ...................................................................................37 D. Determination of Assistance Modalities and Duration of the IOS........................38

APPENDIXES 1. Energy 2. Agriculture 3. Health 4. Environment 5. Public Sector Management

BASIC DATA

Latest Year

A. Selected Demographic and Social Indicators

Area (000 km2) 491.2

Population Total (million) 5.6 (2001) Density (persons per km2) 11.5 (2001) Average annual growth (% per annum, since 1991) 3.3 (2000) Average GNP per capita ($) a 840.0 (2000) Urban population (% of total population) 46.0 (2001)

Health Life expectancy at birth (years) 66.3 (2000) Infant mortality rate (per 1,000 live births) 19.1 (2001) Maternal mortality rate (per 100,000 live births) 47.0 (2000) Mortality rate (per 1,000 people) 5.4 (2000) Hospital beds (per 10,000 people) 50.4 (2000) Public expenditure on health (% GDP) 2.9 (1999) Access to piped water (% of population) 61.0 (1999) Urban 85.0 (1999) Rural 42.0 (1999) Access to sewerage system (% of population) 40.0 (1996)

Education Adult literacy rate (age 15 and above) 98.0 (1999) Primary School Enrolment (% of school age population) 90.0 (2000) Primary school student-teacher ratio 23.3 (2000) Public expenditure on education (% GDP) 5.5 (1999)

Human development index 0.7 (1999)

B. Selected Environmental Indicators

Arable land (% of total land) 4.0 (2001) Forest area (% of total land) 7.0 (2000) Total domestic energy consumption (million tons) 9.8 (1996) GDP per unit of energy use ($ per kg oil equivalent) 0.2 (1997) Annual fresh water withdrawal per capita (cubic meters) 3,635.0 (1999) kg = kilogram, km2 = square kilometer. a Atlas method. Sources: GOT - Government of Turkmenistan, HDR - United Nations Development Program Human Development Report, N.Y., andWDI - World Bank World Development Indicators, Washington D.C.

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BASIC DATA — continued

C. Selected Macroeconomic Indicators Source 1993 1994 1995 1996 1997 1998 1999 2000 2001Nominal GDP (billion Manat)

GOT 10 87 652 7,751 11,109 13,995 17,187 25,700 31,000

Nominal GDP (million $ at official rate)

Derived n.a. 4,579 5,874 2,379 2,681 2,862 3,305 4,403 5,962

Real GDP growth rate (%) GOT (10.0) (17.3) (7.2) (6.7) (11.4) 7.0 16.0 17.6 20.6 Average annual growth of industrial output (%)

GOT 0.4 (24.7) (8.8) 18.5 (20.3) 1.3 16.0 60.0 27.0

Average annual growth of agricultural output (%)

GOT 8.7 (4.5) 1.3 (33.3) 20.6 24.4 26.0 22.0 22.8

Employment and wages Total employment ('000 persons)

GOT 1,627.9 1,691.5 1,748.7 1,780.3 1,815.9 1,838.7 1,871.5 1,950.4 n.a.

Real average wage (% change)

GOT na na (35.6) (12.3) 39.8 25.4 2.0 97.0 43.0

Inflation (period average in %) GOT na 2,562.1 1,005.3 992.4 83.7 16.7 23.5 7.4 5.6 Broad money (% of GDP) GOT 21.0 21.1 18.0 5.5 7.8 11.0 10.6 13.0 12.9

Government finance (% GDP) Revenue GOT na 16.9 20.5 16.6 24.9 23.2 21.0 26.0 25.0 Expenditure GOT na 19.3 20.1 16.3 25.0 26.0 20.1 25.7 24.0 Overall balance GOT na (2.4) 0.4 0.3 (0.2) (2.7) 0.9 0.3 1.0

External sector Exports (million $) IFS 2,692.7 2,175.8 2,084.4 1,691.3 774.0 614.1 1,187.0 2,513.0 2,632.0 Imports (million $) IFS 1,592.7 1,690.1 1,643.6 1,388.3 1,005.0 1,137.1 1,478.0 1,723.0 2,097.0 Trade balance (million $) IFS 1,100.0 485.7 440.8 303.0 (231.0) (523.0) (291.0) 790.0 535.0 Current account balance (% of GDP)

IMF 20.1 1.8 1.3 0.1 (21.6) (32.7) (18.0) (13.0) 1.9

Foreign Direct Investments (million $)

IFS 79.0 103.0 233.0 129.0 108.0 125.0 100.0 131.0 170.1

Gross official reserves (million $)

BOPS 927 1,170 1,172 1,285 1,379 1,607 1,854 1,935

Gross official reserves (months of imports)

IFS 6.0 7.0 8.9 10.1 15.3 14.6 13.0 9.0 8.0

External debt (% of GDP) IFS 4.4 9.0 29.7 28.1 50.6 61.1 53.9 – –Total debt service ratio (% of exports)

IFS – 1.8 13.5 16.1 35.1 97.6 55.1 – –

Official exchange rate (Manat per $, period average)

IFS – 19 111 3,258 4,143 4,890 5,200 5,200 5,200

Official exchange rate (Manat per $ end-of-period)

IFS 3 75 200 4,070 4,165 5,200 5,200 5,200 5,200

Parallel market rate (manat per $ end-of-period)

IMF – – – 5,200 5,350 12,100 15,000 21,000 22,000

— = not available, GDP = gross domestic product. Sources:GOT - Government of Turkmenistan, EBRD - European Bank for Reconstruction and Development, IFS - International Financial Statistics, and IMF - International Monetary Fund.

EXECUTIVE SUMMARY

Turkmenistan gained independence from the former Soviet Union in October 1991. A profound contraction of the Turkmen economy followed1 largely because of a sharp decrease in gas production mainly due to external demand shocks. Most of Turkmenistan’s gas was exported to Commonwealth of Independent States (CIS) countries, which experienced severe payment problems causing gas exports to be reduced and eventually suspended completely in 1997, 1998, and first half of 1999. In addition, agriculture yields declined sharply due to a combination of adverse weather conditions and poor agricultural practices. Since 1998 strong growth has resumed with real gross domestic product (GDP) growth reaching 16% in 1999, 17.6% in 2000, and 20.5% in 2001. This impressive growth was mainly due to a resumption of gas exports to the Russian Federation and Ukraine, improved agricultural performance, and strong state-led investments, some of which were designed to diversify the industrial structure and increase processing of primary goods both for exports and domestic markets.2 According to official statistics, in 2000, real GDP had increased to above the 1993 level. This strong GDP growth in the last 3 years is, however, not sufficient to offset the impact of the sharp decline during 1996–1998 and the high rate of population growth, averaging 3.3% between 1991 and 2000. As a result, per capita incomes declined during the first period after independence and only started to recover in recent years.

Until the end of 1997, inflation was persistently high (peaking at around 2,500% in

1994), causing a dramatic drop in real wages despite the substantial increase in nominal wages. This declining trend in real wages was reversed after 1997 as the Government successfully managed to reduce and control inflation, while nominal wages continued to increase. Year-on-year inflation was reduced to 7.5% in 2000 and to 5.6% in 2001. By end-1999, real wages were back to pre-independence levels.

The consolidated fiscal position is difficult to assess since significant spending is

undertaken outside of the official state budget, using extrabudgetary funds with non-transparent transactions. According to official statistics, since independence, state budget deficits have remained under control, with a budget surplus equivalent to 0.3% of GDP recorded in 2000, and 0.7% in 2001. Yet the official figures released do not include the large structural deficit as reflected in the high levels of debt accumulated by the ministries and numerous off-budget funds. In 1998, the International Monetary Fund (IMF) estimated that the consolidated fiscal deficit reached 15% of GDP against an official state budget deficit of 2.7% of GDP. More recent estimates are not available.

The external position deteriorated after independence, with a current account deficit

reaching 33% of GDP in 1998, mainly caused by a very difficult export situation. With the resumption of gas exports to the Russian Federation and Ukraine, the trade balance improved with a recorded trade surplus of $790 million in 2000. Yet, despite this positive development, the current account remained in a deficit equivalent to 13% of GDP. This was mainly a result of a growing deficit for the services account reflected in large debt servicing requirements of the public, and external debt and financing for the extensive state-led investment program (mostly infrastructure projects undertaken by foreign companies in the capital, Ashgabat). Despite

1 According to official statistics, real GDP dropped by a cumulative 37% between 1993 and 1997, when the GDP

decline bottomed out. Official statistics are not available prior to 1993. The International Monetary Fund estimates that real GDP dropped by almost 50% between 1990 (pre-independence) and 1997.

2 The strong state-led investments also include all the construction projects in Ashgabat, which may not fall under the government efforts to diversify the economy.

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exports increasing by only 5.7% and imports by 22%, a trade surplus of $535 million was generated in 2001. This has helped produce a current account surplus of 0.1% of GDP in 2001. The increase in trade surplus over the last 3 years and the resulting buildup of foreign exchange reserves have considerably improved the country’s external account position. As a result, its external debt servicing burden remains within manageable levels. Gross official reserves covered about 12 months of imports at the end of 2001 because of the accumulation of oil and gas revenues deposited in the Foreign Exchange Reserve Fund. However, the levels of foreign investments at merely $170.1 million in 2001, and of multilateral assistance remain relatively low.

Positive GDP growth is likely to continue in the coming years, provided stable

arrangements for gas exports can be maintained. Overall, natural gas, oil, and cotton will remain the main drivers of economic growth in Turkmenistan, but some diversification in the industry and agriculture sectors is taking place with active support of and promotion by the Government. Private sector growth is strongest in retail trade, but also beginning to become important in the manufacturing and financial sectors, though often in collaboration with public sector agencies. While the economy remains vulnerable to external shocks, the Government’s declared policy objective is to reduce this vulnerability by 2010.

Since independence, the Government’s policies have been characterized by a desire to

avoid socioeconomic disruption or undue dependence on external sources. The Government has tried to diversify its production structure and to capture a greater share of value added by developing its textile and food processing industry. In addition, the Government has pursued a gradual and cautious approach to transition. While small-scale trading and service operations have largely been privatized, little progress has been made on privatizing medium and large enterprises. Some of the institutional and legal foundations of a market economy have been developed, but the business environment remains overall heavily regulated. The foreign exchange regime is highly distorted, with a restrictive exchange rationing system, and a wide difference between the market and the official rate (the spread has stabilized over the past couple of years and is now almost fourfold). The degree of financial intermediation is low. Although this is reinforced by the heavy regulation and lack of competition in banking, it derives more fundamentally from the continuing role of the Government in directing credit, which leaves little scope for market-determined allocations of capital.

The Government’s rationale for adopting a very gradual approach to structural reforms

has been the need to minimize the negative social impact of transition and to maintain social and political stability. Despite relatively low cash incomes, basic human needs have been met through an extensive system of subsidies and allowances. This system has kept the incidence of poverty low. However, some deterioration in the quality of public services, which operate under financial constraints, is already visible. For instance, while the basic education system continues to provide near universal literacy, the quality of the curriculum in some school segments, and access to preschool and higher education have declined in recent years. The Government has implemented major policies to improve the health care system. While it is still early to evaluate the outcomes of these policies, initial feedback shows that these initiatives have yielded significant improvements in basic health indicators in recent years. With a rapidly growing population and a very young demographic profile, the Government will have to allocate increasing resources to effectively meet the demand for these services and sustain quality. To some extent it is already achieving this by steadily increasing budgeted public expenditure for health and education during the last 2 years.

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Turkmenistan joined the CIS in December 1991 and became a member of the United Nations and IMF in March 1992. It joined the World Bank in September 1992 and the European Bank for Reconstruction and Development at the end of that year. It became a member of the Islamic Development Bank in November 1994 and joined the Asian Development Bank (ADB) in August 2000. The country’s experience with multilateral development institutions, while still relatively short, has been varied and sometimes a testing one. The IMF is likely to recommence its Article IV consultations later this year, and the World Bank may develop a country strategy in October 2002.

The strategic objectives of the Government’s medium term (up to 2010) development

strategy in conjunction with our economic analysis provide the framework for ADB’s Interim Operational Strategy (IOS) for Turkmenistan. Within the framework of the 2010 strategy and its four objectives and in line with ADB’s own long term strategic mandate, the IOS has adopted the gradual and sustainable increase in living standards of the Turkmen population as its principal purpose or overarching goal. The three strategic objectives for the IOS that will help achieve its overall goal are identified as: (i) enhancing human and social development; (ii) supporting sustainable and stable economic growth in Turkmenistan; and (iii) promoting regional economic cooperation.

In the context of its three strategic objectives, the IOS will focus on: (i) securing the provision of improved basic services for the population, such as clean drinking water, sanitation and heating, especially for select rural population groups; (ii) maintaining and upgrading the human resource base; (iii) capacity building to improve public sector management as the Government is likely to continue playing an important developmental role in coming years; (iv) improving production efficiency and related policies in agriculture and; (v) ensuring better environment management by focusing on water saving irrigation technologies and helping conserve water use in other sectors as well.

IOS proposes to support Turkmenistan’s desire to play a more active role in regional economic cooperation and in restoring security, stability and economic growth in Central Asia. The crucial importance of this role has become ever more evident in the aftermath of the 11 September events. Already Turkmenistan has played a major role in the ongoing transfer of massive volumes of humanitarian supplies to Afghanistan. The country has unique advantages in this regard with its strategic geographic location that provides the most efficient transport corridor in to northern and western Afghanistan and its long established social cultural and economic ties with Afghanistan. These can be effectively used for providing much needed and immediate relief to the Afghan people from food, medical and power shortages, and ensure better access to education and health facilities. These aspects are also reflected in the high level bilateral protocol signed between the two Presidents in February 2002. Therefore, a number of potential projects are being identified for ADB to provide support for Turkmenistan’s active involvement in the reconstruction and rehabilitation of Afghanistan. Our discussions with other donors make it amply clear that ADB’s effort in this direction are likely to receive the widest donor support.

ADB operations in Turkmenistan will proceed gradually. The IOS focuses on selective

interventions, such as pilot-scale initiatives whose successes could be subsequently replicated on a larger scale. In addition, the IOS will be implemented in a phased manner, focusing initially on nonlending activities, namely technical assistance for training and institutional strengthening, as well as in-depth economic and sector analyses in sectors in which a suitable policy environment and absorptive capacity exists for potential ADB lending operations. Lending

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operations would commence, based on fulfillment of specific conditions for proceeding with each investment project, including government commitment to any required sector reforms to realize the full benefits of the investment. Given the Government’s keen interest in collaborating on the reconstruction of Afghanistan, the enabling conditions for investments supporting regional cooperation will likely be established quickly.

Based on present conditions, the IOS recommends a tentative level of technical assistance operations of $2.5 million per year. Lending levels during the IOS period will be determined once lending operations are warranted.

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I. COUNTRY BACKGROUND

A. Geography and Population

1. Turkmenistan is located in the southernmost part of Central Asia, bounded on the east by Uzbekistan, on the south by Afghanistan and the Islamic Republic of Iran (Iran), on the west by the Caspian Sea, and on the north by Kazakhstan. It covers an area of 491,200 square kilometers, the fourth largest land mass of the former Soviet Union (FSU) republics, but with desert covering 80% and mountains 15% of the territory; arable land constitutes about 4% of total land area. The eastern border with Uzbekistan is largely formed by the Amu Darya River, which provides most of the country’s water resources. The other rivers have local importance, feeding the Tedzren and Mary oases, before disappearing into the desert. The capital, Ashgabat, lies close to the southern border with Iran. 2. Turkmenistan’s population has grown rapidly since independence with an average annual growth rate of 3.3% between 1992 and 2000. In 2001, the population was 5.6 million, making its population density (around 12 persons per square kilometer) among the lowest in Asia. Around two thirds of the rise in population resulted from natural increase and the rest from the immigration of ethnic Turkmen previously residing in other republics. The population is extremely young—more than four times as many ethnic Turkmen are entering the workforce as leaving it. In 2000, about half the population was of working age (defined as men between the ages of 16 and 65 and women between the ages of 16 and 62), 6.1% were above the working age. About 80% of the population were ethnic Turkmen (compared with 72% in 1989), while Russians made up around 8%. The number of Russians seeking to emigrate has risen substantially in recent years, following a government decision that all official business be conducted in Turkmen from 2000. Uzbek, who live mostly near the Turkmen-Uzbek border form the second largest minority, approximately 55% of the population live in rural areas. Overall, the population is mainly concentrated in the oases of the south and is predominantly Muslim (90%). Ashgabat, the capital city, has a population of around 650,000. B. Administration and Political Setting

3. Turkmenistan declared independence from the then Soviet Union on 27 October 1991. A constitution was adopted in May 1992 to vest all political and executive power in the President. The Halk Maslahaty (People’s Council) is the highest representative body, composed of the President, parliamentary deputies, one elected deputy from each district, the chairperson of the Supreme Court, Cabinet of Ministers, and various state officials. It approves the overall direction of government policy and has sole authority to make changes to the Constitution. The smaller unicameral Mejlis (Parliament) comprises 50 members elected by constituencies through an absolute majority vote for 5-year terms. The Cabinet of Ministers is appointed by the President and is responsible for conducting the daily business of the Government. The President also serves as Prime Minister. 4. President Saparmurat Niyazov, first secretary of the Communist Party of the Turkmen Soviet Republic since 1985, and President since October 1990 when the post was created, was unanimously elected President of the new country in a direct election on 21 June 1992. In 1992, he was awarded the title of Turkmenbashi (Head of all Turkmen). In a January 1994 referendum, 99.9% of the electorate voted to extend President Niyazov's term in office to the year 2002, and on 28 December 1999 the Halk Maslahaty removed all limits on the President’s term, making him president for life. However, in February 2001, President Niyazov announced that he would step down in 2010, at 70 years of age. Parliamentary elections were held in 1994, 1998, and December 1999. The next parliamentary elections are due by December 2004.

2 5. The country is administratively divided into five regions (velayats): Akhal (in the center),

Balkan (in the west), Dashovuz (in the north), Lebap (in the east), and Mary (in the south). Ashgabat has the status of a velayat. The velayats are controlled by the hyakims (provincial governors), who are appointed by and directly report to the President. C. Structure of the Economy

6. The cornerstone of the Turkmen economy is energy. With estimated natural gas reserves ranging from 13 to 21 trillion cubic meter (m3), Turkmenistan possesses the fourth largest natural gas reserves in the world after the Russian Federation, the United States (US), and Iran. The country also has considerable oil reserves, estimated at 1.7 billion barrels, and is the fourth largest oil producer among Commonwealth of Independent States (CIS) countries. Turkmenistan’s significant mineral reserves are as yet underdeveloped. In 2000, industry accounted for 38% of gross domestic product (GDP) and employed 18% of the labor force. Agriculture is the second most important sector, accounting for 26% of GDP and 48% of the labor force. Cotton has been the dominant crop, and Turkmenistan is among the 10 leading cotton producers in the world. Since independence, wheat production has increased substantially under the Government’s program to achieve self-sufficiency in grain. By 2000, roughly equal shares (35%) of the arable land were devoted to wheat and cotton. However, the cotton retains strategic importance as a source of export earnings (cotton is exported after processing into cotton fiber, while wheat is consumed domestically). The large share of GDP accounted for by the construction and services sector reflects an ambitious domestic construction program. Because of its landlocked position, it is the country’s access to major global markets is by overland routes, which have a long history as exemplified by the historic Silk Road. This rather difficult access to global markets adds to transactions costs. 7. The economy is highly dependent on external trade, with a trade intensity ratio (export and import as percent of GDP) reaching 96% in 2000.1 This declined to 93% in 2001. Prior to independence, Turkmenistan supplied energy and cotton to other Soviet republics and imported most consumer and capital goods. In 2001, natural gas, oil products, and cotton still accounted for more than 90% of Turkmenistan’s export. Because of this economic legacy, and especially the pipeline network of the Soviet period, the majority of exports (51% in 2001) are still channeled to other CIS member countries. The specialization in natural resources (gas, oil, and cotton) together with heavy reliance on CIS export markets has rendered Turkmenistan vulnerable to adverse external shocks. After independence, Turkmenistan was heavily dependent on imports of foodstuff and manufactured goods. Much of the energy trade was conducted under barter agreement whereby energy exports were traded against low-quality imports, often valued at prices that did not reflect world market prices. Few mechanisms were in place to ensure that such imports matched local demands. Under this framework, the Government launched its program to achieve self-sufficiency in grains, namely to reduce its dependence on imports of basic foodstuff. The share of food imports has been reduced from 20% in 1993 to 7% in 2001, after peaking at 32% in 1996 (a particularly bad year for agriculture). D. Data Issues

8. Official statistics in Turkmenistan, like those in other FSU republics, show some weaknesses. First, given multiple exchange rates, the methodology for estimating value added in different sectors of the economy, especially those in which exports are predominant, is neither well established nor clearly articulated. Second, the central government budget is not completely transparent and has limited coverage as a number of ministries, government agencies, and associated funds are off-budget. Third, balance of payments data are weak. 1 The official exchange rate was used to convert GDP figures to $.

3

More than a quarter of total export earnings continue to be received in either barter or clearing units, complicating valuation, as these may not properly reflect actual market prices. Fourth, in 1998 the Government stopped publishing official external debt estimates; data prior to that are estimates of the International Monetary Fund (IMF). Given these data weaknesses, precisely assessing Turkmenistan’s economic performance over the last decade and its future prospects is difficult.

II. ECONOMIC DEVELOPMENT AND TRANSITION

A. Economic Development

1. Macroeconomic Performance

9. In the years following independence Turkmenistan suffered a substantial fall in GDP due to the disruption of traditional trading and other overall economic relations with the outside world.2 While terms of trade shifted significantly in favor of the country as a result of the move from artificial prices to world market prices for its energy and cotton exports, dependence on Russian pipelines restricted Turkmenistan’s choice of export markets for natural gas and oil. During the early 1990s, several CIS customers experienced serious problems in honoring their payments for Turkmen gas imports. The payments issue came to a head in 1997 when Turkmenistan cut off supplies, and as a result GDP contracted significantly (by more than 11%). Since 1998, however, real GDP growth has resumed with a 7% growth rate during the same year (due to strong agricultural performance), 16% in 1999, 17.6% in 2000, and 20.5% in 2001, due to resumption of large-scale gas exports to the Russian Federation and Ukraine, improved agricultural performance, and strong state-led investment. According to official statistics, by the end of 2000, real GDP was just above the 1993 levels (106%). This is, however, not sufficient to offset the impact of the sharp decline in GDP during the previous 3 years and of the high rate of population growth, averaging 3.3% between 1992 and 2000. As a result, per capita incomes declined during the post - independence period, and only in the last 2 years have started to recover to pre-independence levels.

10. The sharp economic downturn during 1994–1997 (Table 1) was a result of a collapse of gas exports to the Russian Federation and East European importers, due to payment problems; and adverse weather conditions that saw cotton and wheat production also decline precipitously. Shortage of export earnings and difficulties in arranging adequate quantities of imports combined with a sharp decline in wheat production in 1996, from a level already insufficient to meet domestic demand, made food shortages a real possibility. These adverse economic outcomes in the mid-1990s made the Government acutely aware of the need to diversify the economy and achieve a degree of food self-sufficiency. Consequently, the Government took some important steps to diversify the economy and reduce its reliance on natural gas production for achieving growth and on imports for meeting domestic cereal demand. By the end of 2000, these two objectives had been achieved to some extent. Wheat production in 2000 was more than three times the level in 1993, although some imports are still necessary and account for about 20% of domestic consumption.

2 According to official statistics, real GDP dropped by a cumulative 27.4% between 1993 and 1997, when the GDP

decline bottomed out. Official statistics are not available prior to 1993. A new national account system was introduced in 1993; pre- and post-1993 figures are not comparable. However, IMF estimates that real GDP dropped by almost 50% between 1990 (pre-independence) and 1997.

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Table 1: Real GDP Index and Production Indices for Selected Commodities, 1994–2001 (Index: 1993=100)

Item 1994 1995 1996 1997 1998 1999 2000 2001

Real GDP 82.7 76.7 81.6 72.6 77.7 90.5 106.5 144.2 Gas 54.7 49.4 53.8 26.5 20.3 35.1 72.0 86.5 Oil 94.9 102.2 96.4 124.8 154.3 172.0 172.0 192.1 Cotton 95.7 74.6 32.6 47.3 52.7 97.2 96.9 106.9 Wheat 139.9 176.0 89.0 138.9 244.6 320.6 334.0 393.7 GDP = gross domestic product Source: International Monetary Fund and Turkmen authorities.

11. The increase in the share of value added in the agriculture sector in total GDP, from 18% in 1993 to 26% at the end of 2000 is the most noticeable change in the sector composition of GDP (Figures 1a and 1b). This primarily resulted from the decline of the share of industry, including gas production, from 46% to 38% during the same period. However, within industry, the gas subsector still is predominant, although its contribution to aggregate value added in the industry sector has come down in recent years as a result of the Government’s diversification policies. The share of the services sector, including construction activities has remained unchanged at about 36% in 2000 compared with 35.5% in 1993. However, during this period, construction’s share of total GDP decreased to 10% in 2000, signifying stronger growth of retail trade and hotel and restaurant sector, which have expanded with the active participation of the private sector.

Figure 1a: Structure of Gross Domestic Product in 1993

Source: Turkmen authorities.

Electricity2.6%

Construction/Services

36%

Nonenergy15.2%

Agriculture18.3%

Oil4.9%

Gas23.4%

Energy31%

Total Industry(46%)

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Figure 1b: Structure of Gross Domestic Product in 2001

Source: Turkmen authorities.

12. Agriculture output declined by a cumulative 28% during 1993–1998. This was because production of cotton dropped due to a combination of factors including adverse weather conditions, shifting of some land from cotton to wheat, and a large decline in raw cotton production yields. Yields decreased from an average 2.3 tons per hectare during 1990–1995 to 1.2–1.3 tons per hectare in 1998. The decline in yields was itself a result of several interrelated factors such as (i) large-scale organizational changes in the agriculture sector with the state farms (kolkhozes) being converted to farmers’ associations (dekhan beshirats); (ii) transition problems that affected supplies of necessary inputs; (iii) weak financial incentives caused by lagging government procurement prices; and (iv) poor agriculture management that continued to be based on the past Soviet practices of extensive and wasteful use of inputs, including irrigation. Since 1997, strong positive growth in agriculture has resumed due to better harvests of cotton and wheat. According to official government statistics, the sector posted growth of more than 20% each year from 1997 to 2001.

13. The energy sector’s share in total GDP declined from 31% in 1993 to about 24% in 2001. This reflects the reduced share of the gas sector in total GDP, which fell from 23% in 1993 to about 16% in 2001. As a result of government policy to promote the production of crude oil and downstream products, energy sector output now comprises a higher share of crude oil and oil products whose output nearly doubled between 1993 and 2000. Nonetheless, earnings from natural gas exports, still predominantly routed to the Russian Federation and other CIS countries, continue to determine the country’s overall economic trends. The sharp increase in GDP growth since 1999 has been largely a result of restoring gas supplies to these countries and opening a new pipeline to Iran, which now accounts for about 10–15% of total gas exports.

Electricity1.1%

Construction/ Services

32%

Nonenergy12.0%

Agriculture30.9%

Oil7.6%

Gas15.6%

Energy24%

Total Industry (36%)

6 14. In addition, considerable efforts, some supported with significant public subsidies, have

been made to expand the share of the manufacturing sector in the economy and change the industrial orientation from extractive sectors to processing of agroproducts and other light industry. A number of agroprocessing plants, some utilizing credit lines from multilateral development agencies, such as the European Bank for Reconstruction and Development (EBRD) have been established. As a result, the share of light industry, including food processing grew from 24% of total industrial production in 1993 to 37% in 1999. The most significant success has been achieved in cotton-processing, where five modern plants, some of them fully vertically integrated and embodying technology of international standards, were established. These have led to the share of cotton fiber processed domestically increasing from 3% in 1991 to 30% in 2000.

15. The construction and services sectors have been booming since independence.3 Most of the construction was undertaken by foreign contractors and financed partly by foreign loans. The share of services and construction in GDP increased from 35.5% in 1993 to 41.9% in 1999. The informal private sector is also flourishing, engaged mostly in retail trade, construction, and transportation services. Official estimates on the size of the informal sector range from 26% of GDP by the National Institute of Statistics and Forecasting to 18% by the Ministry of Economy and Finance in 1998. At the end of 2000, the private sector’s share in total GDP was estimated at about 40%. According to official statistics, retail trade contributed the most at 74%, agriculture 62%, and industry 26%.

2. Wages and Employment 16. Basic wages in the public sector4 are set in accordance with a wage scale that differs by occupation and length of employment. Private enterprises are free to set their own wages. The period of economic hardship following independence resulted in sharply lower real wages (Figure 2). Although the Government raised nominal wages of public sector employees, real wages fell by a cumulative 43% during 1995–1996, with the increase in nominal wages falling short of inflation. Since 1997, however, this trend has been reversed. Real wages grew by 40% in 1997 and 25% in 1998. By 1998–1999, real wages were back to 1993 levels. In 2000, real wages increased and reportedly almost doubled. Nominal wages in Turkmenistan remain quite low, with an average monthly wage equivalent approximately to $114 (using the official exchange rate) or $35 (using the market rate).5 Taken together with nonmoney incomes, which account for a considerable part of the total household budget, these wages represent a standard of living that is comparable to other CARs. 17. Turkmenistan guarantees employment to every citizen. Workers who register at labor exchanges, established in 1997, are not counted as unemployed and have to accept the exchange’s offer of employment to avoid being delisted. According to available data, in 2000, about 51,000 persons were registered at these exchanges and about 380,000 new jobs were created in the economy during 1992–2000. Little information is available on the private labor market and official unemployment figures do not exist.

3 New projects included the refurbishing of the Turkmenbashi refinery, pipeline to Iran, and the construction of

several banks, hotels, office buildings, and monuments. 4 The National Institute of Statistics and Forecasting only reports public wage data. 5 Clearly the level of real wages will be higher if estimated in purchasing power parities dollars. However, a consistent

series for purchasing power parities conversion rates is not available for Turkmenistan.

7

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Figure 2. Trends in Nominal and Real Wages, 1995–2001 Source: Turkmen authorities

3. Public Finance 18. Unlike most other CIS countries, Turkmenistan did not incur a fiscal crisis after independence. The Ministry of Economy and Finance tried to limit expenditures to available revenues. According to official statistics, fiscal balances appeared to be under control with modest surpluses and deficits lower than 3% of GDP being incurred during 1994–1998. Since 1999, the central budget has consistently shown a small surplus of between 0.3 and 1.0% of GDP for 1999 to 2001. 19. Total budget revenues rose from 17% of GDP in 1996 to 26% in 2000, but have declined to 25.0% in 2001. The decline in 1996 was a result of low revenues from gas and cotton, which continue to account for a predominant share of public revenues. Revenues from cotton and gas are received both as direct contributions from gross profits, a large part of which is surrendered to the designated off-budget funds or as tax revenues. In 2001, value-added tax accounted for 27% of total budget revenue, while profit tax contribution accounted for 11% in 2001. Other principal taxes were income and property taxes, both accounting for 11% of total revenues and a number of assorted taxes and levies made up the remaining 50%. As in other transition economies, clearly distinguishing between budget and nonbudget sources of government revenues is difficult in Turkmenistan. These are often dependent on executive decisions allocating specific shares of revenues from the export-earning sectors to the budget or off-budget funds. These decisions, which are not always implemented transparently, determine the amount that remains within the control of the Ministry of Economy and Finance and is accountable within the budget. 20. On the expenditure side, total expenditures, as a percent of GDP, largely mirrored the changes in revenue. In an attempt to offset the impact of inflation, the Government raised public sector wages substantially between 1994 and 2000 and earmarked increasing levels of budgetary resources for the provision of social services (education and health) and social protection. As a result, public expenditures on education, health, and social welfare increased substantially from 8.7% of GDP in 1994 to 13% in 1999, and further to 18.5% in 2001.

8 21. In addition to the traditional state budget, extrabudgetary funds receive statutorily

defined revenues to meet sector-specific expenditure requirements.6 The main extrabudgetary funds are (i) the Oil and Gas Fund, the largest sector fund, which receives revenues from oil and gas export proceeds and covers investment operations including the production, marketing, construction, and exploration in the oil and gas sectors; (ii) the Agricultural Development Fund financed mainly by the sale of cotton fiber; and whose expenditures are mainly directed to financing input subsidies for cotton and wheat growers under the state order system; (iii) the Transport and Communication Fund primarily used to finance investment projects and maintenance; (iv) the Health Fund funded by a 4% health levy imposed on workers’ wages and used to subsidize pharmaceutical and dental care for the general population; (v) the Education Fund, which finances scholarships and investment in public schools and colleges; and finally (vi) the Foreign Exchange reserve Fund, the largest fund, which derives revenues mainly from compulsory surrender of foreign exchange earnings from all exports including a partial collection from gas and oil exports. The FERF is managed by the Central Bank of Turkmenistan (CBT), under the overall guidance and supervision of the President, in a largely nontransparent manner. 22. Self-financing ministries supervise the activities of the many nonfinancial public enterprises. These enterprises provide cross-subsidies for essential goods (such as water, gas, bread, and salt) to the general population and fund a limited range of services (such as health and preschool services) for their employees (although these services are progressively being phased out). The nonfinancial public enterprises are also responsible for implementing the largely foreign-financed development program, including major energy, agriculture, and transport projects. Most of the foreign loans raised to finance such projects are guaranteed by the Government and effectively secured against the international reserves held by the FERF. However, information is not presently published on the operations of these enterprises. The main self-financing ministries are foreign economic relations, oil and gas, agriculture and water supply, building materials, and energy and industry. 23. Overall, the consolidated fiscal position is rather difficult to assess since significant spending is undertaken by the off-budget entities like the state funds and self-financing ministries and agencies. The funds also accumulate reserves as expenditures can be lower than revenues in any one year. Their detailed transactions are not systematically published or included in the state budget. In recent years, however, the Government has taken some initial steps to expand the coverage of the state budget and introduce internationally comparable budget and accounting practices with technical assistance (TA) from external assistance agencies. The aggregate revenues of these state funds are now included in the consolidated budget document.

4. Monetary Developments and Inflation 24. Government control over monetary policy and commercial banks’ activities remains significant in Turkmenistan. The majority of banks’ lending operations consist of onlending by state banks of directed CBT credit and foreign loans contracted or guaranteed by the Government. CBT, which conducts its management of liquidity broadly according to international practices, supervises all commercial banks in the country. Its supervisory authority extends over the State Bank for Foreign Economic Affairs of Turkmenistan (Vnesheconombank), which is the Government’s agent for foreign investments. Government ownership of banks has increased since 1998, while CBT control over bank lending has been tightened. The level of financial intermediation remains very low. CBT’s relending rate to 6 The Natural Oil and Petroleum Fund was shown to have a revenue of Tmm16.97 trillion in 2000 and of Tmm18.11

trillion in 2001. The 12 state funds, whose annual revenues are reported in the Consolidated Budget Law, had a total revenue of Tmm35.41 trillion in 2000 and Tmm36.12 trillion in 2001.

9

commercial banks was 20% in 2000 and reduced to 15% in 2001. Credit to government borrowers and to the wheat and cotton farmers, participating in the Government’s procurement scheme, was provided at concessional rates of interest. Foreign exchange sales have been CBT’s main monetary instrument to regulate liquidity in the commercial banking system.7 25. CBT is responsible for formulating and conducting monetary and foreign exchange policy, and managing the country’s international financial reserves. CBT is also responsible for running the weekly currency exchange auctions in cooperation with the Foreign Exchange Committee. However, a substantial part of the country’s foreign exchange reserves are not held in CBT but rather in the FERF, which receives a designated share of export earnings from exports of natural gas, cotton, and other sectors. 26. Money supply expanded rapidly after independence, with broad money rising by more than 500% per annum during 1994–1996. The strong monetary growth stemmed from the authorities’ expansive financial policy as the CBT extended large amounts of credit to the economic entities, a large part of which was interest-free, short-term, directed credit to agriculture and textile sectors or credit to the Government to finance its budget deficit. The use of expansive fiscal policy that pushed up the money supply during 1994–98 should be seen in the context of the very sharp decline in export demand from CIS countries as a result of their severe payment problems. This helped to increase domestic demand and compensate for the near collapse of export demand during 1996–1998. Inflation, as measured by the consumer price index, peaked at over 2,500% in 1994. This was apparently not a result of the expansionary fiscal policy that came with effect in later years. Instead the high level of inflation in the immediate post-independence year was due to shortages of essential goods whose imports were severely disrupted as part of the transition and shifting to alternate supply sources. After 1997, with gas exports picking up momentum, monetary policy was successfully tightened by limiting the growth of credit and money supply, improving loan collection, and containing the state budget deficit mainly through expenditure compression. Consequently the annual rate of inflation was reduced rapidly to 84% in 1997, and 24% in 1999, and 7.5% in 2000, partly because of the tight monetary stance and also because of the subsidization of basic consumer goods. According to official estimates, the inflation rate declined to 5.6% in 2001. 27. Through a decree in December 1998, the authorities introduced measures to restructure the banking system. Bank supervision has been strengthened with support from the World Bank and IMF. However, the banking system as a whole remains underdeveloped. The system now consists of CBT and 13 commercial banks, comprising 5 fully state-owned banks, 5 joint-stock commercial banks, 1 commercial bank, and 2 foreign bank branches.8 Public sector banks account for more than 90 % of all commercial bank assets and almost all foreign currency loans. In the same 1998 decree, each state-owned bank was allocated a specific sector of the economy to service: Daykhanbank is to focus on agriculture, Investbank on industry, and Turkmenbank on social infrastructure (trade and services). Vnesheconombank remains the channel used for financing large investment projects with foreign funds, including onlending to state enterprises of external loans contracted or guaranteed by the Government. The latest bank, the President’s Bank, created in February 2000, targets small and medium enterprises (SMEs) specializing in nontraditional manufacturing sectors to promote economic diversification. Its role is similar to any industrial development bank that not only provides subsidized credit to SMEs but also promotes entrepreneurship and private sector development.

7 Yet, CBT has access to only a part of Turkmenistan’s total foreign exchange reserves, part of which are held in the

FERF. 8 Sedarat Bank, Pakistan has a branch while the Deutsche Bank, Germany has a representative office.

10

5. External Sector Developments 28. Turkmenistan introduced its national currency—the manta (Tmm)—in November 1993 at the exchange rate of Tmm2 per $1. The foreign exchange rate devalued to Tmm75 to $1 at the end of 1994. From January 1995 a double rate appeared: Tmm75 to $1 (for accounting purposes and customs payments) and Tmm220 to $1 for exchange operations. In 1997, due to a sharp decline in gas exports, and to nonpayments by customers, the exchange rate reached Tmm4,165 and Tmm5,500 to $1. Taking into account exacerbation of foreign exchange problems in the absence of gas exports, in 1998 CBT introduced a single official exchange rate of Tmm5,200 to slow inflation and stabilize the exchange rate. Following the Russian Federation’s economic crisis in August 1998, the manat again came under considerable pressure, forcing the Government to close the commercial banks’ foreign exchange window in early December 1998. This measure pushed numerous transactions into the parallel market, with the exchange rate in this market reaching Tmm19,000 in April 1999. The spread between the official and the black market rate has since widened further, with the market rate reaching Tmm22,000 in June 2001 against the official exchange rate that has remained unchanged at Tmm5,200.9 The country’s foreign exchange regime continues to be characterized by a dual exchange rate with the market exchange rate, which has somewhat stabilized during the last 2 years, being four times the official exchange rate. This system needs to be carefully reviewed to ascertain its effectiveness for promoting GDP growth; supporting the development of the private sector, especially SMEs; and attracting foreign direct investment. 29. Overall, during the post-independence period, Turkmenistan’s balance of payments has steadily improved. However, the balance of payments position deteriorated sharply during 1997–1998 when the current account moved from a surplus of $776 million (20% of GDP) at the end of 1993 to a record deficit of about $930 million (33% of GDP) in 1998. The principal factor responsible for this unfavorable trend was the severe export contraction between 1994 and 1997 due to the economic and concomitant payment crisis in the Russian Federation and CIS countries that continued to absorb more than half of total exports until 2000. During 1994–1997, the share of exports to the Russian Federation and CIS countries, part of them accounted for in “clearing units,” was very high and made Turkmenistan highly vulnerable to external shocks arising from economic difficulties in these countries. Since 1998, however, with the resumption of gas exports to the Russian Federation and through its pipeline to Armenia, Georgia, and Ukraine; the commissioning of a new gas pipeline to Iran; and rise in world energy prices; Turkmenistan’s trade balance has improved significantly, with a recorded trade surplus of $790 million in 2000. Despite this positive development, the current account remained in deficit equivalent to 13% of GDP, mainly as a result of the growing outflow from the services account. This changed in 2001 with the positive trade balance of $535 million and lower outflows from the services account, resulting in a marginal current account surplus.

9 The Government’s exchange rate management policy has a degree of ambiguity. The market rate is commonly

used by government agencies and departments for settling external transactions. Public sector enterprises and agencies also transact business at the market exchange rate with no overt legal impediments. The use of the official exchange rate seems to be confined to estimating of public external debt and its servicing and to corporations that have generated incomes in domestic currency but are authorized to repatriate incomes/profits internationally. Commercial banks and even government agencies reportedly use multiple exchange rates depending on the sector and nature of transaction.

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30. Turkmenistan’s export earnings are predominantly generated from sales of natural gas, oil and oil products, and cotton fiber (Table 2). These accounted for 85% of total export earnings in 1993 and 59% in 2000. The decline in their share reflects the increasing diversification of exports, especially of downstream oil products and textile manufacturers. While oil and gas exports are still directed mainly to other CIS countries, the principal destinations for cotton fiber exports have gradually shifted from CIS countries to hard currency regions such as Europe, Iran, Southeast Asia, and Turkey. Turkmenistan still relies primarily on imports of foodstuff and manufactured goods to meet domestic consumption needs, although the increase in domestic wheat production in recent years has reduced the need for grain imports, which declined by 8% in 2000 from the 1999 level. This decline in wheat imports continued in 2001. About 29% of imports originated from CIS countries in 2001 (this share has decreased significantly since independence), with Germany, USA, Japan and Turkey emerging as other major import sources. 31. The capital account has improved significantly in recent years, changing from a deficit of $551 million in 1993 to a surplus of $870 million in 1998. Turkmenistan’s claims on other countries for unpaid gas bills declined for the first time in 1997, as CIS importers stepped up payments for previous gas exports and new arrears on gas exports became modest. In recent years, however, the Government has intensified foreign borrowing to finance domestic infrastructure projects. The stock of external debt surged from 4% of GDP in 1993 to 54% in 1999, most of which is long-term debt owed by the public sector and guaranteed by the Government. 32. Reflecting the rise in external debt and the fall in export earnings, the debt service ratio increased rapidly from zero in 1993 to 98% in 1998, but declined to 55% in 1999 following a sharp increase in export revenue. The country’s net external debt position does not appear to be so bleak if the total amount of export revenues owed to Turkmenistan for its gas exports are taken into account, but the probability of repayment of these arrears is not very high.10 The resumption of gas exports to the Russian Federation have helped boost gross official reserves, which were built up from $0.93 billion in 1994 to over $1.8 billion in 2000 and further to attract more 2 billion, being sufficient to provide 12 months of import cover.

33. Foreign investors have been offered a number of facilities and privileges, including tax breaks, freedom from currency surrender requirements, and location in free economic zones. Nevertheless, foreign direct investment grew only moderately from $79 million in 1993 to $233 million in 1995, and declined to around $100 million in 1999 before recovering marginally to $170 million in 2001. With oil exploration in the Caspian Sea not as successful as earlier hoped and significant outstanding problems in transport arrangements for gas exports, interest in production-sharing agreements in oil exploration has declined. The uncertain legal and regulatory environment, combined with the complicated and unpredictable foreign exchange regime has further eroded foreign investors’ confidence and interest in investment opportunities in the country.

10 The probability of repayment is not high because these countries continue to face external payment difficulties.

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Table 2: Trade Structure, 1993–2001

($ million)

Trade Structure 1993 1994 1995 1996 1997 1998 1999 2000 2001

Exports (by trade partners) 2,692.7 2,175.8 2,146.7 1,681.5 751.0 594.0 1,187.0 2,506.0 2,632.0 CISa – 1,669.0 1,188.0 1,171.6 450.9 152.0 489.2 1,314.1 1,342.3

Non-CIS – 507.0 958.7 509.9 300.1 442.0 697.7 1,191.5 1,289.7

Exports (by main type of products)

2,692.7 2,175.8 2,146.7 1,681.5 751.0 594.0 1,187.0 2,506.0 2,632.3

Natural Gas 1,860.0 1,430.0 970.5 1,021.9 273.7 69.5 388.9 1,244.4 1,500.8 Cotton Fiber 427.8 363.3 790.5 331.8 83.6 135.6 209.8 223.4 254.2 Oil and Oil Products 186.4 186.2 221.3 195.8 246.2 236.0 352.2 755.0 699.3 Other 218.5 196.3 164.4 138.6 147.5 152.9 236.1 283.2 178.0

Imports (by trade partners) 1,592.7 1,690.1 1,113.4 1,011.1 1,183.4 1,007.5 1,478.0 1,785.0 2,097.0 CIS – 972.9 737.7 561.3 652.6 477.6 500.1 677.9 608.1

Non-CIS – 717.3 375.7 449.8 530.8 530.0 977.9 1,107.1 1,488.9

Imports (by main type of products)

1,592.7 1,690.1 1,113.4 1,011.1 1,183.4 1,007.5 1,478.0 1,785.0 2,097.0

Manufactured Goods 583.0 970.0 571.7 480.8 763.5 750.6 903.2 1,232.3 1,589.1 Consumer goods 623.0 594.0 541.7 530.3 419.9 256.9 574.8 552.7 507.9 Foodstuffs 322.0 247.0 284.6 323.8 290.3 91.0 221.5 204.4 146.7 Non-Foodstuffs 301.0 347.0 257.1 206.5 129.6 166.2 353.3 348.3 361.2

Trade Balance 1,100.0 485.7 1,033.3 670.4 (432.4) (413.5) (291.0) 721.0 535.0

– = not available. a CIS = The Commonwealth of Independent States include Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russion Federation, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. Source: Turkmen authorities.

34. At the time of independence, Turkmenistan was predominantly a primary goods producer with a very large share, nearly four fifth, of its national income being generated either through cotton monoculture or gas exports to CIS partners. In terms of industrial capacity and management capability it was perhaps the least developed of all the FSU economies. Since independence, the economy suffered from major transition problems, adverse weather conditions, and external shocks. It has also faced considerable difficulties in transporting gas and receiving payments from countries importing its gas. It is therefore to Turkmenistan’s credit that it emerged from these adverse transition and external conditions, and according to official statistics, achieve positive GDP growth since 1998, including double-digit growth since 1999. However, despite some success in economic diversification, as a result of an active government policy, the dependence on cotton and gas is still a central feature of the economy. The economy also remains highly vulnerable to external shocks; this perhaps highlights the fragility of its current strong GDP growth. The public sector continues to dominate nearly all aspects of economic activity either directly as an economic agent or through extensive regulation and control. The scope for private domestic and foreign investment has consequently remained fairly restricted. This reflects a weak institutional framework and lack of predictability in

13

economic management. This implies that to achieve high and sustainable growth rates in the medium to long term, an active agenda of structural reforms, whose pace and direction will be determined by the specific conditions prevailing in the country, will have to be pursued. B. Economic Reforms and Progress in Transition

35. Turkmenistan’s economic policies have been characterized by a cautious and gradual approach to structural reforms with the objective of minimizing social disruption and dependence on external sources. Reducing dependence on exogenous factors has been difficult given the predominance of primary production, and the nature of the inherited transport infrastructure, in particular the pipeline and rail networks, which only permit restricted access to external markets. The Government is working to overcome these constraints by trying to diversify the economic structure and export destinations, and searching actively for alternate supply outlets for these exports. Economic diversification has shown some progress with 30% of raw cotton now being processed domestically and a sharp increase in the production of oil products from the recently renovated Turkmenbashi refinery. The success achieved in establishing alternate export outlets for gas has been limited as only one new pipeline to Iran has come onstream and the direction of foreign trade, while undergoing some change, is still concentrated on the Russian Federation and CIS countries. In its attempt to minimize social hardships and disruption, the Government has tried to maintain the living standards for its population by providing high levels of subsidization for basic goods and services, such as water, gas, electricity, and salt, which are provided free or close to free to households. 36. Following a People’s Council resolution of December 1992, the Government adopted a 10-year transition and stabilization period before prices, trade, and enterprise activity would be left to be determined primarily by market forces. Subsequently, in December 1999 the Government published the National Program of Socio-Economic Development up to 2010 (the 2010 strategy). The strategy identifies four primary goals: (i) economic independence that implies a high rate of economic growth with macroeconomic stability, economic diversification and efficient use of resources, privatization and support for entrepreneurship based on guaranteeing ownership rights, and integration into the world economy along with promotion of foreign investment; (ii) food security based on increasing the supply of domestically produced foodstuffs, and strict quality control of agricultural exports and imported food products; (iii) enhanced social security, safeguarding of labor rights, and provision of employment for the population; increased real incomes of workers; strengthened social safety net for the vulnerable segments of the population; and guaranteed inviolability of private ownership; and (iv) ecological safety to ensure that industrial development takes account of environmental concerns, prevention of an ecological disaster in the Aral Sea region, provision of high-quality drinking water for the population, safe use of chemicals in agriculture, and prevention of soil erosion and salinity. Selected targets for the strategy are given in Table 3.

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Table 3: Selected Benchmarks for 2010 Strategy Indicator 2000 2005 2010Average annual growth rate of GDP 2000-2010 18% GDP structure

GDP 100.0 100.0 100.0 Industry 38.8 43.2 32.3 of which gas 20.0 14.9 8.3 Agriculture 26.0 21.8 15.4 of which cotton 4.9 3.8 2.0 Construction 10.0 8.7 7.2 Services 25.2 26.3 45.1

Inflation Rate (%) – 6.0 4.0 Share of Private Sector (% of GDP) – 56.6 66.6 Labor Market

Labor force ('000s) 2,655.0 3,550.0 4,511.0 Unemployment (%) 1.6 2.2 2.0

Production of Industrial Products Oil and gas condesate (million tons) 10.0 28.0 48.0 of which export 2.5 16.0 33.0 Natural gas (billion cubic meters) 38.0 85.0 120.0 of which export 33.5 70.0 100.0 Primary refining of oil (million tons) 7.0 12.0 15.0 Light Industry Cotton fiber ('000 tons) 450.0 750.0 900.0 of which export 213.2 637.0 662.0

Agriculture Number of leaseholds ('000) 402.2 372.6 177.2 Landowners 15.8 58.3 408.3 Main Crops Wheat Area ('000 ha) 655.1 677.1 705.6 Yield (c/ha) 24.7 32.5 42.5 Gross Crop (c/ha) 1,645.0 2,200.0 3,000.0 Raw Cotton Area ('000 ha) 573.0 621.0 662.6 Yield (c/ha) 26.2 40.3 45.3 Gross Crop (c/ha) 1,500.0 2,500.0 3,000.0

Social Development Life expectancy (yrs.) 68.3 72.6 75.0 GDP per capita (US$PPP) 4,273.0 7,769.0 14,781.0 Human development index 0.678 (98) – 0.879

Education Children attending kindergarten – – 482,000.0 Children attending secondary school 1,100,000.0 – 1,500,000.0 Students in public university – 30,600.0 42,200.0 Students in private higher education – 5,300.0 28,500.0

Health Number of diagnostic centers – 15.0 40.0 Privately financed hospital bed (% total) 3.8 8.3 14.0 Family doctors (per 10,000) 6.5 10.0 10.0

Other health targets to be achieved Reduce mortality rate from cardiovascular disease by 30% by 2005. Reduce mortality rate from oncology and virus hepatitis diseases by 25% by 2005. Reduce mortality rate from infectious diseases by 20% by 2005. Reduce mortality rate from tuberculosis by 15% by 2005. Reach zero incidence of polio infection by 2005. Reach zero incidence of measles infection by 2010.

— = not available, GDP = gross domestic product, ha = hectares. Sources: Government of Turkmenistan, Strategy of Socio-Economic Developments in Turkmenistan for the Period Up to 2010.

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37. In the initial years after independence, the Government adopted a more active liberalization and deregulation policy stance that encouraged the establishment of private banks, growth of the private sector, and a relatively liberal foreign exchange regime in which a number of commercial banks were allowed access to foreign exchange markets. A conjunction of several factors during 1994–1997 resulted in a marked change in the Government’s policy approach. These included a sharp deprecation of the manat during 1993–1998; the severe drought of 1996–1997 that resulted in food shortages exacerbated by the inability to import from CIS suppliers of food grains (Georgia and Ukraine) because of payment problems and related disputes on foreign trade; the near stoppage of gas exports as the Russian crisis led to severe import compression in the Russian Federation and other CIS importers; and a perception that speculators and some private investors were misusing the foreign exchange regime. 38. The revised policy approach, adopted since 1998, emphasizes gradual and sequenced change and a continuation of a major role for the Government in economic activity both directly as an investor and indirectly as a regulator. This apparent reversal of the agenda for structural reforms coincided with a marked improvement in the performance of the economy—though a result almost entirely of favorable external circumstances. One consequence of the improved economic performance is reduced urgency to implement reforms. The Asian crisis and its relatively modest impact on less-integrated economies like the People’s Republic of China and India have also strengthened domestic lobbies that support a gradual and sequenced approach to reforms. As a result, Turkmenistan’s progress with the implementation of structural reforms in the last 10 years and especially since 1997, and the transition to a market economy has been limited. The EBRD liberalization index ranks Turkmenistan as the least reformed of all the transition economies. 39. The financial sector remains largely in public sector control. While the Government has taken important steps toward private ownership of agriculture land, prices of both agro-inputs and products remain controlled. Retail trade prices were liberalized soon after independence and the share of the retail trade conducted by nonstate entities has grown rapidly. However, key prices, including the exchange and interest rates, continue to remain tightly regulated. Privatization has proceeded slowly and centered almost exclusively on small enterprises in the services sector. The 2010 strategy foresees an expansion of the role of the private sector, and envisages the completion of privatization of all small, and most medium, and large enterprises. However, the most important firms in the industry and transport sectors including the state-owned oil and gas monopoly are to remain out of reach of any private owners, foreign or domestic. 40. In contrast to the declared objectives of the 2010 strategy, the growth of private SMEs is seriously lagging. The number of small and medium Turkish investors declined from 440 in 1997 to about 130 now. Disbursements from EBRD’s credit lines have almost come to a stop after an initially strong showing. Some of the more active private sector activity is now taking place in the informal market, which according to estimates, accounts for about 26% of total GDP. The most important factors constraining expansion of the private sector relate to the foreign exchange and trade regimes. These remain nontransparent and with highly unpredictable access to rationed supplies of foreign exchange. In August 2000, the Government tightened foreign exchange and trade regimes by requiring that foreign currency accounts of all firms that have any foreign exchange dealings be maintained by CBT. According to official sources this was done because speculators and dishonest bank customers were misusing the existing foreign exchange regime. Currency auctions, held irregularly, are designed to primarily service the foreign exchange requirements of public sector enterprises. While import tariffs are low, significant trade barriers remain, including rationing of foreign exchange, export licensing requirements, and a requirement that all imported goods must be prepaid. The more stringent

16

import controls are implemented through the State Commodity Exchange, where almost all trade must be registered. Such registrations are reported to be time consuming and costly because of complicated bureaucratic procedures and nontransparent governance systems.

III. DEVELOPMENT ISSUES

41. The four main development issues for Turkmenistan are (i) economic growth based on the development of key productive sectors; (ii) social security and social development, which rely on increased growth and the Government’s distributive and social protection policies; (iii) maintenance of ecological balance and environmental protection; and (iv) good governance as a necessary condition for efficient public resource utilization and growth of the private sector. A. Economic Growth: Development of the Productive Sectors

1. Energy

42. The engine driving the Turkmenistan economy for the foreseeable future will be the resource-based export sectors, energy, and cotton. Earnings from gas exports will remain dependent on exogenously determined world prices and the terms of trade offered by principal importers, which at present are the Russian Federation and TransCaspian CIS countries.11 The Russian Federation is likely to play the lead role in price negotiations, given its strong bargaining position arising from the ownership of the main pipeline that transports nearly 90% of Turkmen gas exports at present. 43. After peaking at 90 billion m3 in 1989, Turkmenistan’s annual gas exports declined to an average of 24 billion m3 during 1994–1996. Until January 1996, gas exports were under the control of the Ministry of Oil and Gas and all shipments were guaranteed under intergovernmental arrangements. Subsequently, such guarantees were discontinued and gas exports were conducted through direct arrangements between trading enterprises. With a view to ensuring payments and reaccessing European markets, in January 1996, Turkmenistan entered a joint venture (Turkmenrosgaz) with Gazprom (45% share) and a US-based Russian trading company, Itera, (4% share) to develop and export its gas. Under the agreement, Itera was responsible for marketing the gas at a price of $42 per 1,000m3, and collect 53% of the payments due in goods and 47% in cash. However, following further deterioration of the payment situation, Turkmenistan stopped all gas shipments as of end-March 1997 and unilaterally terminated Turkmenrosgaz in June 1997. Gas exports plunged to 6.5 billion m3 for the year and real GDP declined by more than 11%. Gas exports were negligible in 1998 (at only 1.7 billion m3 for the year through small deliveries to Iran via a new pipeline that became operational at the end of 1997) and resumed through the Soviet pipeline network in 1999 and 2000 (with only 10.5 billion m3 exported in 1999 due to a temporary suspension of gas sales to Ukraine from May to December 1999, but more than 35 billion m3 were exported in 2000). Total gas exports through the Russian pipeline in 2001 are expected to be nearly 36 billion m3. According to existing agreements, 26% of the total payment is in clearing units that can be used to import a range of goods and services; and the rest is in cash. 44. While Turkmenistan’s oil and gas industries hold tremendous promise, major obstacles stand in the way. First, the country’s ability to develop its vast gas and oil resources is complicated by geography. The country is landlocked and hence must develop a pipeline infrastructure to link its resources to external markets. This will necessitate finding reliable partners for both right-of-way access through neighboring states and foreign investors to construct potential pipelines. Currently, Turkmenistan must rely almost entirely on the Russian 11 These refer to the Caucasus and Southeast European countries, which are principal importers of gas from

Turkmenistan.

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pipeline network and a pipeline link to Iran to export its oil and gas. This dependence on the Russian pipeline system has constrained development and foreign investments in the sector. Therefore, Turkmenistan is trying its best to develop alternate supply routes for its natural gas exports. 45. Efforts to construct new international pipelines have been ongoing for most of the 1990s with limited results so far. The gas pipeline to Iran completed in December 1997 is the only pipeline in Central Asia to bypass the Russian Federation. However, its capacity is rather small at 8 billion m3 per year, of which only 3–5 billion m3 have been used so far. For the next contract, starting in 2002, Iran could offer a price lower than the present $41.06 per thousand m3, in line with falling global oil and gas prices. The TransCaspian pipeline to Turkey via Azerbaijan and Georgia to be constructed by a joint venture could provide another significant option for Turkmenistan’s gas exports.12 These projects, plus plans to export gas to the People’s Republic of China via Kazakhstan and to Pakistan via Afghanistan, should help Turkmenistan obtain better terms of trade for its gas exports.13 46. Future prospects for expanding export earnings from gas will depend crucially on constructing efficient alternative supply links to potential markets, and developing extractive capacity. Most likely financed by foreign investments, this will require that a predictable and transparent policy framework and simplified foreign exchange regime be established as soon as possible. The Government also needs to clarify its position on the extent of regulatory control and the level of participation it desires in future production-sharing agreements. The current trend with some major oil companies shutting down their offices in the country and foreign investors shying away from investment opportunities needs to be reversed if Turkmenistan is to fully exploit its natural resource endowments. Clear demonstration of commitment to needed structural reforms and establishment of streamlined and transparent governance systems are essential conditions for attracting foreign investment in resource extraction and processing. 47. Developments of alternative energy transportation routes. However, the political risks are high. These political risks can be mitigated if a subregional intergovernmental cooperation framework can be established to bring Turkmenistan in the mainstream of such ongoing regional cooperation efforts in Central Asia. The Government has shown an awareness of such initiatives and expressed the intention to examine the benefits from participating in regional cooperation programs, while adhering to its policy of independence and strict neutrality.

2. Agriculture

48. Agriculture is the second most important sector in the economy, both as a major source of employment (48% of the labor force was employed in agriculture in 1999) and export earnings (about 20% of export revenues were derived from cotton in 1999). With arable land constituting only about 4% of total land area and an extremely arid climate, agriculture is irrigation dependent. The major source of irrigation is the 1,500-kilometer long Karakum main canal, a legacy from the Soviet era, which brings water from the Amu Darya River. The canal transformed the geo-environment conditions in Turkmenistan, giving it the means for sustained agriculture growth. However, some of the adverse effects of canal mismanagement and inefficient irrigation practices can now be seen in the increasing salinization and degradation of arable lands. The Government has launched the ambitious Turkmen Lake project to restore some of these lands by improving drainage and recycling irrigated water.

12 Apparently the TransCaspian pipeline initiative has now come to a standstill with Azerbaijan and Turkmenistan

being unable to come to any agreement on production sharing. 13 A serious private sector effort to negotiate with Afghanistan for a pipeline to Pakistan was aborted in 1999 due to

political instability in Afghanistan.

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49. In the Soviet days, the agriculture sector was predominantly a cotton monoculture with some production of fruits and vegetables destined for markets within the FSU itself. This has changed since independence as a result of the Government’s policy of achieving food self sufficiency and diversifying the agriculture sector by encouraging higher value addition and processing within the country. The most important crops today are cotton and wheat. Turkmenistan also produces livestock, fruits, and vegetables for domestic consumption. 50. As a result of poor harvests in 1996, partly attributable to drought conditions in 1995 and 1996, the authorities initiated a program of land reform. By the end of 1998, members of farmers associations received plots of land, normally between 2 and 50 hectares. These leases are given for a 15-year period on the understanding that farmers agree to cultivate wheat and cotton on a major part of the holding, and meet government production and procurement targets. The supply of inputs, normally on heavily subsidized terms, is dependent on the farmers’ willingness to abide by these production and procurements agreements.14 Farmers are free to use the remaining area to produce other cash crops like fruits and vegetables that are sold for cash in local markets or exported. Upon expiry of the lease and more generally at the end of 2 years of satisfactory performance, the land passes into private ownership by the farmer, although land transfers outside of the immediate family remain restricted.15 Even under private ownership, however, farmers have to enter into and abide by the production agreements if they want access to subsidized inputs. 51. By 1999, over 90% of the arable land had been leased under the land reform program and resulted in the formation of 595 farmers associations (Deykhan Bilishek). These produced about 90% of total cotton and 85% of wheat in 2000. Each member has to pay 9% of gross income toward the association’s management fees. As members of the farmers association, the farmers also have access to subsidized technical services (such as tractors and harvesters) from the service organization (turkmen ober khizmat) attached to each farmers association. Most livestock production has been transferred into private hands. The Government continues to exert significant control over the agriculture sector, primarily through state orders. Virtually the entire harvests of the two key crops, cotton and wheat, are still under state procurement at prices that are considerably below world market prices.16 The procurement price for cotton was fixed at Tmm1 million per ton in 2000 and for wheat at Tmm80,000 per ton. At the market exchange rate, these translate to $47.6 and $38 per ton respectively as compared with the prevailing 2000 world market prices of $1,300 per ton for cotton and $147 per ton for wheat. The low procurement prices for cotton and grain are partly a result of the Government providing all important agro imports like seeds, fertilizers, and pesticides at highly subsidized rates. Credit is also made available at a zero or minimal interest rate. 52. Agriculture output decreased by a cumulative 28% during 1993–1996 as production of cotton went down. This decline was due to a small reduction in the amount of land devoted to cotton but most importantly to a large decline in yields, which were only 1.2–1.3 tons per hectare in 1998, compared with an average of 2.3 tons per hectare during 1990–1995. Although the decline in cotton yields could be partly attributed to bad weather, the other important reason was the transition in organizational basis for agriculture from state farms to farmers associations, and in the government agencies responsible for agriculture. The resultant disruption in input supplies and credit, combined with the deterioration in land quality due to 14 Seeds and pesticides are provided with a subsidy of 50% and fertilizers with a subsidy ranging between 30 and

50% depending on the quality. Technical services are also charged only 50% of costs and credit is provided at 0–1% interest by the Deykhan Bank. Irrigation water is free of charge. Given the controlled prices at which cotton and wheat are procured, the amount of net subsidy is lower but its actual magnitude needs to be determined.

15 Procedural delays and complex transfer processes are reported to cause undue delays in privatization of leased land.

16 State procurement of milk and meat was abolished in January 1997.

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poor irrigation and drainage and overutilization of land, saw yields decline during 1993–1996. These have improved to pre-independence levels in subsequent years, but still remain below levels obtained in similar climatic and land conditions in other countries (for example in the People’s Republic of China where yields range between 3 and 3.5 tons per hectare). 53. Land area allocated for wheat production increased substantially after independence from 260,000 hectares in 1993 to more than 741,000 hectares in 2000, under the Government’s program to achieve self-sufficiency in grain. This was achieved by shifting land away from other crops. Wheat production has increased by almost eight times since independence. Traditionally, most of the wheat consumed in Turkmenistan was imported from Ukraine, which was also the main purchaser of Turkmen gas. Today, wheat is used primarily for domestic consumption and imports have been reduced substantially over the past few years. While yields have improved over the past couple of years reaching slightly above 3 tons per hectare, these are still modest compared with international levels. 54. Since independence, the area allocated to coarse grains has been transferred to wheat. Area under fruits and vegetables, traditional export products from Turkmenistan, has also declined to some extent. The decline in production of animal feed crops conflicts with the reported increase in number of livestock and lower imports of processed animal feeds. This could lead to overgrazing of lands, leading to ecological degradation. 55. Overall, the institutional setting for agriculture remains highly regulated for the two main crops of cotton and wheat. Although precise estimates are not available, both these crops are probably subject to high levels of implicit taxation that withdraws any surplus from the agriculture sector. Although other crops and livestock are not marketed within the state order system, the Government can still influence decisions in these sectors through land allocations, implicit price controls, and the availability of inputs. The incentive system in agriculture is presently highly biased in favor of crops under the state order system. This needs to be made uniform for all crops in order to attract private investment in agriculture. 56. Some reforms are planned under the 2010 strategy. For example, the Government plans to reorganize the processing sector to increase private ownership and investment. The Government also intends to accelerate land reform and increase the number of private landowners. However, key crops are to remain under state control. The Government has set an ambitious target, roughly doubling the production of both wheat and cotton over the next 10 years. This is to be achieved by increasing the area sown (by over 40%) and improving yields. To help rehabilitate cropland, the President has initiated a project to build an artificial lake in the Karakum desert, to collect field run-off from across the country. The run-off irrigation water will be channeled across the country in unlined canals to accumulate in a depression. The run-off will then be desalinated, cleaned, and purified before entering the lake. The project, which is supposed to span 10 years, has three main objectives: (i) to clean up existing water sources by preventing the pesticide-laden waters from returning to the Amu Darya River or the Karakum canal; (ii) to provide new croplands; and (iii) to provide entertainment and water sporting opportunities to the Turkmen people. Each ministry within the Government is required to contribute funds to this project, which is estimated to cost $1.97 billion. Work on this ambitious project has started. 57. Given the severe scarcity of water resources and the water-intensive nature of cotton production, a careful assessment of economic profitability of cotton and wheat production is needed. Such an assessment should consider the effective costs of production, including the environmental costs, that are likely to have been aggravated by the distorted price structure of agriculture products and inputs (including water). The prospects for diversifying agriculture output into fruits, vegetables, and livestock should also be carefully evaluated.

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3. Industry

58. The share of industry in overall economic activity decreased from 46% of GDP in 1993 to 32% in 1999, but increased to 36% in 2001. This share is expected to grow as the production of gas and oil products, and cotton manufacturing increases in coming years. The Government has taken important steps to diversify the economy and reduce the country’s reliance on gas. One of the cornerstones of the Government’s strategy has been to promote the oil sector where production increased significantly between 1993 and 1999. In addition, considerable efforts were made to change the industrial orientation from mining and extracting to producing and processing. As a result, the share of light industry, including food processing, grew from 24% of total industrial production in 1993 to 37% in 1999. The most striking expansion has been in the textile sector; its share increased from 10.4 to 26% of total industrial production over the same period. Between 1995 and 2000, the share of cotton processed domestically rose from 3% to 30% of total production. 59. Other recent industrial developments include a $1.5 billion upgrade of the Turkmenbashi oil refinery and development of an associated petrochemicals complex. A Turkmen-Indian joint venture pharmaceutical plant was built in 1998 to produce up to 75 million capsules per year, as well as various ointments, medical salts, and toothpaste. Smaller joint ventures have been established in food processing and other areas. 60. The Government has embarked on an industrial diversification policy that has three main objectives: increasing the value-added content in primary exports, diversifying the production structure, and achieving self-sufficiency in food products in the country. These objectives were to be achieved through a number of policies that include (i) expanding the capacity for downstream processing of oil products by expanding and modernizing refinery capacities; (ii) increasing capacity for manufacturing petrochemical products; (iii) establishing textile processing plants as joint ventures between the Government and foreign investors, embodying the latest production technologies; and (iv) actively encouraging the setting up or agro-processing units in the SME sectors, some of which are owned by farmers associations or local governments. 61. These industrial policy objectives and measures will move Turkmenistan away from its current near-complete dependence on export earnings of primary products. However, caution is necessary in undertaking this diversification predominantly in the public sector. This can lead to serious errors of judgement in selecting the right foreign investment partners and products for promoting exports, and result in inefficiencies and leakages of revenues from the economy. It may also reverse the healthy trend, observed prior to 1998, of increasing the share of the private sector in the secondary and tertiary sectors. A more balanced and sustainable policy would be to create a regulatory, financial and legal environment in which the private sector would lead the diversification of the economy.

4. Transport and Communications 62. Adequate and speedy development of transport and communication is critical to sustain growth for a landlocked country like Turkmenistan. The country’s transport and communications networks were designed to serve the internal needs of the Tsarist Russian empire and later the FSU. A major task for Turkmenistan since independence has been to reorient these networks to suit the needs of the country, and to diversify the country’s trade route options. 63. In the transport sector, investments undertaken during the 1990s have substantially upgraded rail, road, air, and water transportation facilities. The President has launched a

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program to build new roads and railways, and upgrade existing ones to boost freight and haulage capacity by 50% by 2010.17 Turkmenistan would substantially benefit from being a transit route from other Central Asian countries to the Caspian Sea and on to Europe, and to the Indian Ocean and on to Asia. Realization of such benefits will require substantial improvement in the soft infrastructure of trade facilitation. Until recently, Turkmenistan was reluctant to participate in most regional agreements and therefore generally perceived as relatively isolated in Central Asia. This policy may have been revised in the aftermath of September 2001 events. A reflection of this change in policy towards regional cooperation was Turkmenistan’s high-level participation in the Ministerial Conference on Regional Cooperation organized by ADB in March 2002. Although Turkmenistan has signed several trade agreements and a most favored nation trade agreement with the US, it is not a member of any free trade agreement, nor a member of the CIS Customs Union. It has shown no interest in becoming a member of the World Trade Organization either. Recently, visa regulations, similar to those in force in the Soviet era, were reintroduced for visitors from the CIS. Unless these barriers to trade are lowered or removed, the benefits from a further expansion of the transport network will not be realized. 64. The telecommunications system in Turkmenistan, entirely in the public sector and state controlled, is poor and received relatively little investment, absorbing only $50 million during the past 5 years. At the end of 2000, there were only 82.2 main lines per 1,000 inhabitants. Ambitious developments for the sector have been outlined as part of the 2010 strategy. The Government plans to increase the number of telephone subscribers to 600,000 by 2010, with 260,000 in Ashgabat. The Government’s priorities are to upgrade all communications systems (both telephone and information technology services), install new trunk lines, and develop new international links.18 Modernization is beginning to take place, but the pace has been slow. The current low level of Internet usage, with only 1,700 subscribers in August 2001, highlights the weak development of information technology in the country. In May 2000, the Government revoked the licenses of Internet service providers, leaving the state-owned Turkmentelekom as the monopoly provider.

5. Finance and Banking 65. During the first decade since independence, apart from the retail trade and small-scale services sectors, economic resources continued to be largely allocated by the state, either by directed credits to industrial or infrastructure projects or by tight control over farmers’ decisions via input supplies and other mechanisms supporting the state order system. In this setting, scope for developing banking sector to efficiently intermediate financial resources in the economy is limited.

66. By any standard measures, the degree of financial intermediation remains low in Turkmenistan. Interest rates play only a marginal role in capital allocation, or in monetary policy.

17 In 1996 the rail link from Tedzen to Meshed in Iran was opened. A major upgrading of the Ashgabat airport took

place in the mid-1990s. A new airport terminal was built in 1996 and a second runway designed for heavy aircraft was completed in 1998. A new air traffic control system was installed in 2000. The national airline has purchased six Boeing aircraft to service international routes. The Government has also been active in road construction and upgrading. The country’s major highway from Turkmenbashi on the Caspian Sea to Turkmenabad (Chardzhou) on the border with Uzbekistan has been substantially upgraded. Among the other new roads being built is a north-south link between Ashgabat and Dashovuz, which links the country’s northern velayat more closely to the capital city. A railway is to be built parallel to this new road, with anticipated completion by 2006.

18 Planned investments for 2000–2005 include a substantial upgrading of telephone and information technology services. New digital telephone stations will increase capacity by 165,000 users. Cell and paging communication systems will be augmented by increased satellite access, installation of relay stations, and other facilities. Fiber optic communication lines will be constructed from Ashgabat to Balkanabad (Nebitdag) and Turkmenbashi (618 kilometers, planned for 2001), from Turkmenabad to Atamurat (Kerki) and Kerkichi (243 kilometers, planned for 2001), and from Ashgabat to Dashovuz (783 kilometers, planned for 2002).

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Although these outcomes are reinforced by the heavy regulation and monopolistic structure of the banking system, they derive more fundamentally from the continuing role of the Government in directing credit, leaving little scope for market-determined allocations of capital. Banks’ lending operations in domestic currency are mainly driven by the onlending of directed credits received from CBT primarily to the agriculture sector. With significantly better harvests of both cotton and wheat since 1998, the volume of these directed credits has increased. However, the majority of the loans were repaid, due to the more favorable harvests. Lending by banks in foreign currencies, seems to consist almost entirely of onlending of external loans contracted or guaranteed by the Government, through Vnesheconombank. While these credits are believed to have increased significantly in recent years to finance the ambitious state-led investment program, very little data are available.

67. Banking reforms have made little progress in recent years. The Khartotheka system, which establishes the priority of wage and tax payments over other payments from an enterprise’s bank account, remains in place. Enterprises are consequently reluctant to increase their deposits in commercial banks because the Khartotheka system does not give them full control over their deposited funds. In December 1998, one of the most dynamic domestic private banks was merged with a smaller bank and the management replaced by Presidential decree. Commercial banks have to satisfy CBT’s criteria for access to foreign exchange at the weekly official auctions. For many banks, revenues from foreign exchange trading operations are reported to exceed revenues from lending. 68. Exporters are subject to strict surrender requirements, with typically half of their earnings to be surrendered at the official exchange rate. Part of earnings from oil, gas, and cotton exports is deposited into the FERF and the Oil and Gas Fund. Private enterprises are not subject to the surrender requirements and can hold foreign exchange earnings, but they appear to be penalized if they try to obtain foreign exchange for imported inputs, especially raw materials and foreign equipment that are needed for nonpriority investments. Consequently, private sector export activity is declining. 69. Substantial improvement in efficiencies in financial intermediation will be needed to realize the Government’s 2010 vision. Excessive state control over credit decisions and in the foreign exchange market seriously hampers development of a commercial banking subsector. Some external development agencies have become involved in credit facilitation. The experience of these programs suggests that problems of credit availability for rural or urban potential entrepreneurs are also compounded by other difficulties like licensing procedures, access to imported inputs of new enterprise creation. As a result, demand for small-scale credit is minimal. B. Social Security and Social Development

1. Living Standards and Social Protection 70. During the Soviet rule, Turkmenistan benefited from substantial increases in living standards and social development. Universal access to education and health care and a substantial degree of social protection were provided under the Soviet system despite the faltering economy during the 1980s. Turkmenistan’s human development index of 0.697 in 1991 was lower than that of Kazakhstan (0.774), but ahead of other neighbors such as Uzbekistan (0.664), Kyrgyz Republic (0.689), and Tajikistan (0.629). These human development achievements came under major stress with the end of central planning and start of the transition to a market-based economy.

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71. In all of the FSUs, the transition was accompanied by a severe decline in total output and by increased inequality, which put a serious strain on living standards and social policies. Turkmenistan followed a different approach to transition than other CIS republics. While other CARs reformed their social safety net and abolished the high level of consumer subsidies, Turkmenistan’s highest priority during the transition period was to protect people’s welfare. This was accomplished through a broad system of transfers, subsidies, and social assistance. To maintain this extensive system of social protection, the Government allocates substantial funds through the central budget, extrabudgetary funds, and state companies. During FY2000, 25% of the central budget’s social expenditure went for pension payments, 12% for housing subsidies, and 4% for other services including transport and telephone subsidies. In 2000, the country had only 284,000 old-age pensioners (5% of the population) and the ratio of pensioners to employees was very favorable (16:100). With the adoption of the Law on Pensions in 1998, considerable changes were made to mechanism for financing old age insurance, such as introduction of personal accounts, replacement of the work record with an insurance record, increasing the retirement age, and allowing pensioners to continue working. The law also stipulates the transition from joint pension funds to a fully funded system based on voluntary pension insurance. At the same time, a system of pension payment from funds of state-social insurance to retired citizens still exists, as well as to future pensioners having joined public service prior to the law being enacted. The law also foresees the possibility of nonstate pension funds, but without a capital and security market, no other old age insurance has emerged. The most important items to maintain basic living standards have been budgetary and off-budget subsidies on basic goods and services such as water, gas, electricity, heating, and food items. These subsidies have protected poor members of society. But the universality of these benefits has also raised concern regarding their high costs and the possible regressivity of the system. The costs of provision are difficult to document, because much of the cost occurs off budget and a substantial part of the economic cost should be measured in terms of alternative uses, which are also not economically priced. In an attempt to control excessive usage, some limits are set on free provision, but water and gas use is not metered. Although electricity meters are in use, the charges on consumption above the limit are so small that it is often not worth collecting the fees. Clearly, families in larger houses with more appliances benefit more from free electricity than do poorer families. Free water is also less beneficial to the majority of households that do not have indoor toilets than it is to the wealthy. In addition, these services may not be equally distributed. The centralized heating services, for instance, work much better in Ashgabat than in other cities and towns where supplies are less secure. A major challenge facing the Government has been the cumulative costs of maintaining such generous social policies. While the costs of these subsidies are difficult to estimate (because they are primarily paid by the providing agency, which may in turn receive subsidized inputs), they are real and make it very difficult for the providing institutions to operate on a commercial or efficient basis. In addition, the lack of payment for the maintenance and improvement of services has led to generally poor quality services, and few alternatives are available for those able and willing to pay. 72. While the economic costs of these policies are difficult to estimate, the social benefits for the people are clear. Today, the incidence of poverty in Turkmenistan is among the lowest in Central Asia. A comprehensive household survey, conducted jointly by the World Bank and the National Institute of Statistics and Forecasting in the spring of 1998, showed that average monthly per capita income was about Tmm90,000 ($101 per month in 1998 purchasing power parities terms). Using a poverty line weighted by the purchasing power of the domestic currency (estimated at $2.15 per capita per day), the incidence of poverty in Turkmenistan in 1998 is estimated to have been only 7%, which compares favorably with most of the other CARs.19 Relative poverty, calculated as the population with average per capita monetary incomes below 50% of average individual incomes was 15.4% in 1999. If income in kind, which is important 19 Using the same threshold of $2.15/day, the poverty incidence was estimated at 68% in Tajikistan, 49% in Kyrgyz

Republic, 23.5% in Azerbaijan, and 5.7% in Kazakhstan.

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because of the free provision of public goods and essential commodities, is included, the incidence of poverty drops significantly below the estimates. However, poverty is not evenly distributed, with about three quarters of the poor living in rural areas, and substantial variations between the relatively affluent capital and other regions. The Gini coefficient in Turkmenistan is estimated at 0.41, which is high by eastern European standards. 73. Turkmenistan’s human development index ranking declined from 80th in 1991 to 83rd in 1999, which compares favorably with other CARs (Table 4). This reflects a significant improvement in life expectancy and child mortality over the past couple of years. On the other hand, while Turkmenistan fared best among the CARs in terms of literacy rate prior to independence, by 1999 Turkmenistan had been surpassed by Kazakhstan and Tajikistan.

Table 4: Human Development Indicators for Selected Central Asian Countries

Human Development

Index

Life Expectancy

at birth (yrs.)

Adult Literacy

Rate (%)

Real GNP per capita

($, Atlas method) 1991 1999 Country 1991 1999 1991 1999 1990 1999 Index Rank Index Rank

Kazakhstan 69.0 64.4 97.5 99.0 2,600 1,250 0.774 61 0.742 75 Kyrgyz Rep. 68.0 67.4 97.0 97.0 1,570 300 0.689 82 0.707 92 Tajikistan 70.0 67.4 96.7 99.1 1,130 280 0.629 97 0.660 103 Turkmenistan 66.0 65.9 97.7 98.0 1,690 670 0.697 80 0.730 83 Uzbekistan 69.0 68.7 97.2 88.5 1,340 720 0.664 91 0.698 99

Sources: UNDP, 2001. Human Development Report. N.Y.

2. Education

74. The Constitution of Turkmenistan provides people with free access to all levels of education. Turkmenistan inherited a well-developed education system, which provided universal literacy and high levels of technical training. Shortly after independence the Government announced the implementation of a new education policy, with objectives to (i) reform education to support national revival; (ii) adapt the education system to market conditions; and (iii) protect the education system during transition. The third objective reflects a major constraint as falling GDP reduced the resources available for public and private spending on education, despite the demand generated by high birth rates. The Government committed itself to reform both in response to national independence (as in curriculum reform and the adoption of a new alphabet) and in response to economic conditions, which rendered some Soviet-era vocational training obsolete. 75. Since independence, the Government appears to have increased the share of its budget going to education, although this still represents a decline in real resources available for the education system because of the sharp drop in GDP between 1993 and 1997, accompanied by the high rate of inflation during the mid-1990s. Because of the decline in real resources, the school system has faced problems of low teacher salaries, lack of quality textbooks, and inadequately maintained facilities. With strong GDP growth since 1999, the financial constraints have eased to some extent. 76. The switch to general instruction in the Turkmen language and the revised vision of the history and values of the Turkmen nation presented in new social studies textbooks have added real costs. These have been offset by reducing the number of school years from 10 to 9, and by reducing the number of staff. Many tertiary programs have also been reduced in length. An

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additional concern for higher education is reduced quality of educational achievement by secondary school graduates. There are reports on some more changes in the secondary school curriculum that need to be carefully examined and reviewed. 77. The Government has introduced user fees in some areas of education to help increase available resources. Some of these fees are nominal and others have a strong economic justification (e.g., for vocational training that leads directly to higher earning power). There are also reports of individual institutions levying charges independently of the state budget. 78. All the formerly centrally planned economies are faced with the challenge of maintaining educational standards and access, and no easy solutions are available. The costs of failure to meet this challenge are high because human capital formation is a key factor in economic growth and because unequal access to education creates social divisions. Especially worrying in this context is the decline in access to kindergartens, in rural areas and among poorer children. This may lead to a two-tier entry into the school system at 7 years of age, with urban children having already achieved basic literacy while rural and poorer children have not and are likely to fall permanently behind in their schooling. This view is, however, strongly contrasted by government officials who maintain that for pre-school age children, home-based education supervised by mothers is a tested and perhaps even a better option than sending children to pre-school kindergartens. 79. Although the challenges in education facing all economies in transition are widely recognized, the international assistance community has not been heavily involved in the education sector in Turkmenistan. The United Nations Development Programme (UNDP) prepared a comprehensive education sector review in 1997. Based on the review, UNDP funded and implemented one project in general education, creating a basis on which further external assistance could be developed. The World Bank reportedly has no specific plans for financial support to the education sector. The European Union has been discussing assistance for vocational training.

3. Health 80. The health sector faces many of the same challenges as the education sector. Inherited standards of health care and levels of access were relatively high, although delivery was not always efficient. The Turkmenistan Presidential Health Program, issued in 1995, emphasizes the need to (i) develop family doctor practice and primary health care, (ii) rationalize health services, (iii) improve the quality of care, and (iv) strengthen the health financing system. Under this framework, the Government has embarked upon major health reforms, including health financing (establishment of medical insurance), allocation mechanisms (shifting resources to primary health care from hospital-based care), and service provision (creation of and shift to family doctor practice). The program represents important recognition of the need for a systematic approach to health sector reform, and the Government has taken steps to stimulate much needed improvements in service delivery and to ensure better use of resources in line with needs. While it is still early to evaluate the outcome of these reforms, the direction of reforms is laudable. Early results indicate improvements in recent years have been significant in the maternal and infant mortality rates, as well as life expectancy. 81. Turkmenistan’s basic health indicators were historically the worst in the FSU countries, as a result of poverty (poor living conditions and lack of access to safe water and sanitation); stress from social and economic change; and a lifestyle that often includes heavy reliance on tobacco, alcohol, and an unhealthy diet. Some of these factors can be addressed by intensified health- and hygiene-oriented public education, environmental policies to improve water supply and sanitation, and more effective health management especially in an outpatient setting.

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82. The administration of the public health system, inherited from the Soviet system, has been fully revamped during the past 10 years. With help from a number of external agencies, including the World Health Organization, the Government has attempted to establish a modern public heath system that is based on universal access, achieving efficient utilization of available resources, and a medical insurance system that was introduced for the entire population in 1999. The Ministry of Health and Medical Industry (MOHMI) is responsible for formulating policy, maintaining minimum standards and quality of medical services, and planning and organizing medical services in the country. Under its supervision, the responsibility for delivering health services lies mainly with the regional health authorities. These regional health authorities have a dual reporting structure, to the provincial governors and MOHMI. The budget for the regional authorities is provided directly by the Ministry of Finance and is disbursed by the provincial government. Eighty-six percent of the total budget of the health sector is allocated directly to the regional authorities. MOHMI exercises quality control and is responsible for personnel and organizational issues. The dual track could result in some dilution of responsibility and confusion. Reportedly, the Government is now considering a change to direct funding of the district health centers through MOHMI. Despite some improvements, initiated largely by MOHMI, allocation of resources from Ministry of Finance is largely based on past norms that still emphasize maintenance of physical assets rather than encourage efficiency and quality of medical services. 83. Health is an area in which the Government has already implemented significant reforms, but reforms will need to be continued if the recent improvement in health standards is to be sustained. Although health care services are meant to be free, medication and basic medical equipment are often not available at the health facilities, and patients have to buy these themselves in order to get services. Thus adequate access to care by the more disadvantaged needs to be ensured. Extension of the health insurance scheme introduced in 1996 could generate additional finances for the health sector. But again, the most urgent priority is to strengthen the public resource management system. With a better system in place, Turkmenistan should be able to use its considerable natural resource wealth to successfully address basic health issues.

4. Basic Infrastructure Services

84. Turkmenistan has essentially followed the FSU model of providing basic infrastructure services, such as water, sanitation, heating, and waste disposal and treatment services, basically free of charge. These services are controlled by the central government, with limited input from the end users in cities, towns, and villages. 85. Capital investment in basic infrastructure is usually financed from central government transfers, whereas costs of operation and maintenance have to be covered from local government budgets. However, due to the Government’s policy of subsidizing residents by providing these services either for free or against a symbolic fee, local budgets are incapable of meeting operation and maintenance costs, resulting in deterioration of infrastructure and poor service quality.20 The “problem of the commons” is rampant with no agency to look after the shared assets either in the towns or rural communities.

20 In urban areas, residents complain most about the service quality of water supply and heating, breaks in power

supply, and dirty and damaged entrances to apartment blocks. In rural areas, lack of safe drinking water and sewerage systems are the biggest concerns and the major environmental hazards to human health.

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86. Potable water is provided to residents free of charge. This inevitably results in waste, lack of required repair and maintenance, and deterioration of infrastructure. On average, about 60% of the population have piped water supply. About 85% of urban households, and only about 40% in rural areas are covered by municipal water supplies. Domestic water demand in Ashgabat is estimated by city officials at about 450 liters per person per day. This compares with about 150 in Western Europe.21 87. A policy of providing water free of charge does not set incentives for people to value water as an economic good and to avoid waste. Furthermore, people with access to piped water are favored by this policy compared with low-income groups living in rural areas confronted with limited and poor quality water supply. While water delivery problems and poor maintenance are the main causes for insufficient and insecure water supply, the Government will have to recognize that free water encourages waste, leads to supply shortages, and hampers sustainable development of infrastructure. 88. Contrary to domestic consumers, industry and private enterprises are charged for water consumption and supply is usually metered. Current legislation does not allow for private sector participation in water supply and sanitation except for commercially produced and marketed bottled water. 89. About 44% of the population have access to sewerage systems with a higher connection rate in cities compared with rural areas. Domestic and industrial effluents are usually discharged with little or no treatment into waterways or the desert. However, besides domestic and industrial effluents, a major source of water pollution stems from the application of pesticides and fertilizers in irrigation and agriculture. People in rural areas suffer particularly from the poor state of sanitation characterized by waterborne diseases, requiring urgent upgrading of water supply and sanitation systems. 90. One of the Government’s priorities is to provide the entire population with high-quality drinking water. Construction of drinking water plants is envisaged or has already been carried out, such as in Ashgabat. However, to improve service quality, besides providing additional water sources, considerable investment in network rehabilitation will be required supported by measures to enhance efficiency and to mount public awareness campaigns to improve service quality and rationalize demand by promoting water conservation. 91. The Government has indicated its intention to reform the water and sanitation system by increasing access to safe drinking water and sewerage systems, developing and building capacity of the institutions in charge of water and sanitation services, and improving water quality to limit detrimental impacts on public health. International organizations including the Islamic Development Bank (IDB), UNDP, United States Agency for International Development (USAID), and the World Bank are supporting the Government in its effort to improve water supply and sanitation. 92. Solid waste management is provided by municipal utilities and residents are charged a symbolic fee. Equipment, including waste bins and garbage trucks, is often outdated and in need of replacement. Segregated waste collection is not practiced in Turkmenistan and waste is often dumped or burned in an uncontrolled manner. Besides investment in new equipment and construction of sanitary landfills, public awareness campaigns will be required to improve service quality and to reduce environmental and health hazards for the population. 21 Recent studies indicate that domestic water demand in Ashgabat could actually be even higher. According to

surveys, water production would amount to approximately 1,000 liters per person per day, out of which 25% is lost in the distribution network, another 25% is lost inside apartment blocks (running toilets and taps, defective plumbing, etc.) and 25% is consumed.

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93. District heating, similar to other municipal services, is provided to residents for a symbolic fee. Networks and boilers are in urgent need of repair and replacement. Energy efficiency is low, leaving local administrations confronted with complaints about insufficient service provision. Ashgabat city officials intend to improve the outdated system by restructuring the network into smaller units heated by small boilers; this will require considerable funds. C. Environmental Management

94. The Government recognizes the urgency and importance of sustainable utilization of natural resources. The past damage, complexity of the issue, lack of funds, inadequate economic and environmental policies, and weak institutional capacity are key issues facing the Government. Significantly, ecological safety is one of the four priorities set in the 2010 strategy. 95. The key challenges faced by the country are natural resources degradation, particularly the increasing levels of soil salinity; soil erosion; and declining water quantity and quality. These problems are now seriously undermining the health and livelihood of major segments of the population, especially rural people and low-income groups in urban areas. For example, soil salinization and declining water quality caused by deteriorating irrigation systems have reduced productivity of irrigated farmlands by an estimated 20 to 25%. Deteriorating water quality has led to increased water purification costs and contributed to the outbreaks of waterborne diseases, accounting for 20–40% of health problems. Water resource management is one of the most critical problems facing Turkmenistan. 96. The water resources management issue is complex. First, the issue is multidimensional, involving not only aspects of water quantity and quality per se, but also sedimentation, soil salinization, and erosion. Second, the issue is complicated by the fact that it expands beyond national borders. Hence, effective long-term solutions will depend not only on Turkmenistan’s own efforts but also on regional cooperation. Among the most urgent issues requiring regional cooperation are the ecological damage to the Aral Sea and sedimentation problems in downstream countries. 97. Compared with the problems of natural resources degradation, industrial and urban pollution problems are currently less pressing due to the relatively slow process of urbanization and modest growth in industrial production since independence. Pollution from industrial sources is limited to several large-scale factories within a few sectors, such as oil refining plants in Seidi, the chemical plant in Turkmenabat, the cement plant in Ashgabat, and the nitrogen fertilizer plant in Mary. Motor transport is the main source of urban air pollution. As growth and recovery continue, industrial and urban pollution could become serious issues given the lack of a sound environmental management system and efficient and environmentally effective production equipment. Other environmental concerns include control of solid and hazardous wastes, biological diversity protection, and climate deterioration. 98. To improve environmental management the Government has undertaken a series of measures. For example, a draft water law is currently under consideration that would provide a legal basis for charging for water; a national environment action plan is being prepared; and the Government has signed and ratified a series of international environmental conventions. 99. Despite these efforts, a significant gap still exists between the goal set by the Government and the means that the Government currently has to reach that goal. The main constraints to effective management of the environment and natural resources are (i) fragmented responsibilities for environmental and natural resources management, (ii) lack of a comprehensive plan for land use, (iii) a general belief in engineering solutions, (iv) lack of user

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charges for water, (v) inadequate institutional capacity for policy analysis and implementation, and (vi) inadequate funding. D. Public Sector Management

100. The present budgetary system makes it difficult to ensure that public spending as a whole reflects the Government’s priorities and is used effectively. The Ministry of Economy and Finance manages allocation and oversees only a small portion of government revenues and expenditures through the state budget. The rest is managed by autonomous extrabudgetary funds and ministries that follow their own sector priorities. The management of the external debt is also fragmented, partly under CBT and part under Vnesheconombank. Furthermore, the processes of making public investments and contracting foreign debt are often separated. 101. The 2010 strategy has established strong goals to improve fiscal management. All extrabudgetary accounts are to be eliminated, and all investments are to be included in an investment budget with an appropriate analysis of rates of return. In addition, selected government companies are to be separated from ministries to facilitate privatization. The 2010 strategy also establishes improved external debt management as a key goal, with the target of increasing the country’s credit rating, improving the efficient use of borrowed funds, and establishing a reasonable level of total borrowing and government control. It also proposes a central process for external debt repayments under the government budget. Some progress was made in FY2000 by presenting planned revenues and expenditures outlays for some extrabudgetary funds in the state budget document. With respect to debt management, a Presidential decree was issued in 1999 seeking greater control over the project formulation and loan approval process. Accordingly, all investment projects must be evaluated by the State Agency for Foreign Investment. The deputy chairperson of the Cabinet of Ministers in charge of the national economy must personally sanction all new projects above a certain threshold. The effectiveness of these procedures is not clear. 102. State-owned enterprises and other revenue-generating agencies need to adopt international accounting standards on a phased basis to ensure that financial results are reported more accurately. Non-cash transactions need to be minimized for better financial management of the public sector expenditures. The real issue in improving corporate governance does not appear to be the lack of good laws, but rather the transparent application of those laws. Building a system of public accountability and control is essential. The Government has taken initial steps in this regard by drafting a public procurement law, which is expected to be submitted to Parliament in 2002. Turkmenistan is also beginning to introduce international accounting standards, which should help improve accountability of expenditures. 103. The Government has indicated willingness to eventually transfer power from the central government to the regions. Potential areas for reform include (i) the introduction of a clear legal distinction between functions performed by the deconcentrated and/or the decentralized apparatus, (ii) increased power to levy own revenues at the regional level, and (iii) establishment of representative institutions (such as regional parliaments) to ensure that the local executives at these levels are accountable to their constituencies. Some promising preparatory analytical work is planned in the coming 2 years by the Turkmen National Institute for Democracy and Human Rights to improve the regional government system in Turkmenistan.

E. Relations with International Organizations and External Assistance

104. Turkmenistan joined the CIS in December 1991. It became a member of the United Nations in March 1992, of IMF and the World Bank in September 1992, of EBRD at the end of

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1992, and of IDB in November 1994. The country joined the Asian Development Bank (ADB) on 31 August 2000. 105. According to United Nations estimates, total official development assistance commitments for projects and loans operational in 1999 in Turkmenistan amounted to $355 million. About 80% of this represents capital assistance in investment projects provided mainly through loan agreements. Grant-financed TA accounts for the remaining 20% of concessional inflows. In terms of sector allocation, the environment sector has attracted the largest share (22%) of the total reported grant projects operational in 1999, followed by enterprise and industry (19%), and health (14%). Housing and social services along with trade and commerce received only 2.9 and 0.6% of the total. The trend however looks disappointing as estimated bilateral and multilateral financing changed from $4.8 million in 1999 to $21.4 million in 2000 and decreased to $3.1 million in 2001. This reflects the uncertain relationship of Turkmenistan with the donors, both bilateral and multilateral. 106. In terms of grant-financed TA, the European Union, through its Technical Assistance to Commonwealth of Independent States (TACIS) program, has been by far the largest donor, and has been implementing a wide range of TA projects in Turkmenistan since 1992. TACIS has an interstate program for cross-border projects with annual funding in the region of EUR 31 million, mainly in the infrastructure area. Its most important subprograms for Turkmenistan are INOGATE, which targets the renovation of existing and the construction of new pipelines for oil and gas export within the region and to Europe; and TRACECA, which aims to create a transport corridor from Central Asia through the Caucasus to Europe. Over the years, TACIS seems to have progressively retargeted its resources away from the central government, working increasingly at the local/district level.

1. Multilateral Funding 107. Turkmenistan is currently only eligible for the World Bank’s International Bank for Reconstruction and Development resources. The World Bank’s lending program in Turkmenistan started with a $25 million institution building TA loan, approved in 1994. The loan was to support TA and institution-building efforts in the financial and energy sectors, and improve social safety net administration. The funds were later refocused on budget improvement and computerization, as well as tax and pension systems. Two other loans ($30.3 million for water supply and sanitation to improve water hygiene in the Dashovuz region; and $34.2 million for urban transport improvements in three cities) were approved in 1997. Implementation of these projects was frozen for almost 2 years (until summer 1999) due to a procurement issue. The water project has now resumed implementation, while the transport loan has been canceled. No further lending was extended from FY1998 to FY2000. A new country assistance strategy was approved in January 2001. It is basically a nonlending strategy, unless the Government fulfills three conditions: (i) resolving a negative pledge violation22 and debt reporting requirements; (ii) improving portfolio performance; and (iii) taking basic debt and budget actions, including details on the operations and suggested reforms of the FERF. In the meantime, the World Bank will implement its two ongoing loans and selected TA capacity building activities, focused on transparency and environmental issues. 108. IMF and Turkmenistan have maintained an economic policy dialogue since 1992 through Article IV consultations and staff visits. Turkmenistan has not sought IMF financial

22 The violation is related to a 1996 loan provided by a consortium of foreign banks for the rehabilitation of the

Turkmenbashy Oil Refinery. Proceeds of oil sales are collected in an international collateral account to repay the loan. The Government has since recognized the problem, issued a Presidential decree prohibiting such practices, and indicated that since then, similar operations have not been entered into. However, it has been unable to renegotiate the pertinent clauses of the offending loan.

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support. IMF provided TA and training to strengthen the institutional and human resource capacity needed to implement fiscal management, monetary policy, and effective CBT operations. Until mid-1999, IMF had a resident representative and two permanent advisers on fiscal and monetary matters in Turkmenistan. However, in the absence of significant reforms, they were withdrawn at the end of their assignment and have not been replaced. The next round of Article IV consultations, which was initially scheduled for the third quarter of 2000, has not been completed due to a lack of access to balance of payments, external debt, and budget data. In March 2001, IMF formally took up the issue of nonavailability of data required to complete Article IV discussions with the Government. The issue seems to have been resolved with the visit of an IMF consultation mission in November 2001, which received the necessary information and data to move to an Article IV discussion in 2002.

109. IDB has made commitments in Turkmenistan totaling $26.35 million for the construction of the Turkmenbashi hospital, construction of an oil tanker, and rehabilitation of the Ashgabat to Mary road cofinanced with EBRD and the Kuwait Fund. TA totaling $0.27 million has also been provided for an irrigation canal feasibility study. Several other investment projects are in different stages of processing. 110. EBRD, which has financed more than half of the total lending by IFIs to Turkmenistan, had, as of 31 December 1999, signed four projects totaling $156 million. These projects include a credit line for SME development, a loan and equity investment to expand the textile plant created by the Gap-Turkmen joint venture, a loan for the development of offshore hydrocarbon fields, and financing for the reconstruction of Turkmenbashi port. In addition, 24 technical cooperation projects have been completed or approved that focus on feasibility studies for infrastructure projects. In view of the Government’s slow progress toward economic and political reform, EBRD has put public sector investment projects on temporary hold and now focuses exclusively on private sector development. EBRD’s new country strategy, approved in April 2000, required a review of the progress of reforms within one year. At its meeting in June 2001, the EBRD board noted the continued lack of progress and decided to undertake another review after one year. 111. UNDP’s country strategy focuses on strengthening public services, promoting good governance, generating income, as well as restoring and protecting the environment. Some of these priorities have been overtaken by the aftermath of the 11 September events, which has necessitated greater attention on regions and activities that would facilitate reconstruction in Afghanistan. Given its geographic location, Turkmenistan is being used as a major supply route for channeling relief to northern regions of Afghanistan. This is likely to continue in the foreseeable future as other agencies also find it convenient to use facilities in Turkmenistan to channel both short-term relief and development assistance to Afghanistan. The World Health Organization, the United Nations Children Fund (UNICEF), and the United Nations Population Fund implement programs in the health sector (child health and HIV/AIDS23 prevention mainly). The United Nations Office for Project Services and United Nations High Commissioner for Refugees have also started some operations in the follow-up to 11 September events.

2. Bilateral Assistance 112. The US is the largest bilateral donor in Turkmenistan. Most of the funding is channeled through USAID. USAID funding for 1999 amounted to over $6.5 million and remained unchanged in 2000. The activities are directed primarily at four priority areas, health services and reforms, development of civil society, human resource development for SMEs, and budget

23 HIV refers to human immunodeficiency virus, which is the AIDS virus. AIDS refers to acquired immunodeficiency

syndrome, a disease of the human immune system that is caused by infection with HIV.

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reforms. Through the Central Asian American Enterprise Fund, the US Government finances loans to SMEs and provides equity capital to Turkmen private business ventures. Since beginning operations in 1996, the fund has approved financing of over $20 million. The US EXIM Bank has also extended $424 million in short-term trade credits. Procedural problems, for example the issuance of exit visas for program participants, and difficulties in entering into a policy dialogue with the Government, have led USAID to review its program in the country. 113. Turkey’s EXIM Bank has provided a credit line of $91 million, which has been fully utilized. About half the amount was used for contracts undertaken by Turkish companies in food processing and construction, and the balance spent on imports from Turkey. In addition, the Turkish International Cooperation Agency assisted, among others, in developing a highway and promoting wheat production. Following the 1999 earthquake in Turkey, funding was reduced. 114. The Japan Bank for International Cooperation provided a $40 million loan for modernization of the Ashgabat locomotive depot, and carried out feasibility studies for the transshipment terminal in Serakhs and a railway management information system. It extended loan support for a polypropylene production plant in Turkmenbashi and is currently holding discussions with the Government for possible involvement in various information technology projects. Japan International Cooperation Agency provides assistance mainly through the provision of various training opportunities in the fields of communications, finance, environment, transportation infrastructure, and resources development.

3. International Credit Ratings 115. Turkmenistan has an unusual position as both a major debtor and a major creditor. In January 2000, Fitch confirmed Turkmenistan’s long-term sovereign rating of B minus. This reflected a high debt service burden (estimated at 55% of exports in 1999) but also large foreign exchange reserves (estimated at $1.9 billion in 2000) and a positive short-term outlook for energy exports. While the short-term outlook for oil and gas remains strong, Turkmenistan must be transparent about its debt and debt service situation in order not to affect its creditworthiness. This point became even more apparent, following Fitch’s decision, in May 2001, to downgrade Turkmenistan’s long-term sovereign rating from B minus to CCC minus, and its short-term rating from B to C, prompted by the opaque nature of policymaking in the country and the lack of reliable economic data.

IV. INTERIM OPERATIONAL STRATEGY

A. Background and Approach

116. The strategic objectives of the Government’s medium term (up to 2010) development strategy in conjunction with our economic analysis provide the framework for ADB’s Interim Operational Strategy (IOS) for Turkmenistan. The four strategic objectives of the 2010 strategy are: economic independence, food security, provision of adequate social safety net and ecological safety. Government’s 2010 strategy is premised upon its commitment to undertake a series of structural reforms. These would however, be implemented gradually in keeping with the Government’s policy of minimizing negative social impacts of transition. The Government has so far met the basic needs of the population through an extensive system of subsidies and allowances. Despite the prospects of increasing external revenues, with the resumption of gas exports to traditional markets and potential new export markets, the economic base remains relatively narrow and highly vulnerable to external shocks. Hence, as evidenced from the deterioration in recent years in the quality of some social services, there is continuing concern that the present system of subsidies may not be sustainable. Therefore, policies and measures

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that will achieve a sustainable improvement in the peoples’ living standards will need to be systematically adopted in coming years.

117. Within the framework of the 2010 strategy and its four objectives and in line with ADB’s own long term strategic mandate, the IOS has adopted the gradual and sustainable increase in living standards of the Turkmen population as its principal purpose or overarching goal. The three strategic objectives for the IOS that will help achieve its overall goal are identified as: (i) enhancing human and social development; (ii) supporting sustainable and stable economic growth in Turkmenistan; and (iii) promoting regional economic cooperation. The strategic objectives of the IOS yield some specific areas in which ADB’s operations are likely to be focused. Selection of these areas, that effectively describe the scope of the IOS also reflects ADB’s understanding that promoting a sustainable improvement in living standards goes well beyond income generation per se and includes measures that help improve the general quality of life (basic health, municipal services etc), afford a more equitable access to economic opportunities (technology, employment and financial resources) and allow for faster accretion of human capital (skill formation, training and information technology).

118. ADB operations will proceed gradually, through selective interventions in a limited range of sectors, in consideration of (i) ADB’s relevant experience in other CARs, (ii) opportunities for collaboration with other external aid agencies and for mobilizing cofinancing, and (iii) the Government’s overall reform commitment in the relevant sectors.

119. In addition, the tragic events in the US on 11 September 2001, and their aftermath in neighboring Afghanistan and the region have provided Turkmenistan with an important role in restoring security and political stability, and stimulating economic growth in the subregion. Its geographic, cultural, and economic ties with Afghanistan and policy of strict political neutrality places Turkmenistan in a unique position to provide access to Afghanistan. These exceptional circumstances merit special consideration for ADB to provide selective lending to support Turkmenistan’s involvement in the urgent reconstruction and rehabilitation of Afghanistan, within the period covered by this IOS.

B. Overarching Goal and Strategic Objectives

120. The primary objective of the IOS is to raise the living standards of the people of Turkmenistan in a sustainable manner. This is fully consistent with the Government’s long-term development objectives as described in the 2010 strategy and with ADB’s overarching goal of poverty reduction. The conceptual framework of the IOS is illustrated in Figure 3.

121. The IOS is based on three main strategic objectives: (i) support for human and social development; (ii) achievement of sustainable economic growth; and (iii) promotion of regional cooperation with other developing member countries from Central Asia and the immediate vicinity to restore security, stability, and economic growth in the subregion. The areas of focus under each strategic objective are described here, along with a number of possible operational activities. The identified activities are only indicative and by no means exclusive. They are intended to illustrate the IOS’s areas of priority concern. Other areas of assistance may be considered as they arise, provided that they are consistent with the broad objectives of the IOS.

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Figure 3. Conceptual Framework of the Interim Operational Strategy

Economicindependence

Food safety

Social security

Ecological safety

Strategic Objectivesof the Government's

2010 Strategy

Purpose of ADB'sCountry Strategy for

Assistance toTurkmenistan

Support gradualand sustainable

increase in livingstandards of the

population

Strategic Objectives Areas of Focus

Enhance humanand social

development

Sustainable andstable economic

growth

Improve availability ofbasic public services

Maintain and upgradehuman resources

Capacity building forpublic sectormanagement

Improve efficiency inagricultural production

Environmentalmanagement

Regionalcooperation

Transport

Energy

1. Enhancing Human and Social Development 122. In the context of Turkmenistan, minimizing the social costs of transition and strengthening human resource development are crucial aspects of the country’s development strategy. The Government’s raisson d’etre for pursuing a slow pace of structural reforms is to minimize the negative social consequences of transition. In this respect, the IOS will focus on three areas.

123. First, the IOS will aim to secure provision of improved basic services for the population, such as clean drinking water, sanitation, and heating. The provision of these basic services is critical, especially for the rural population will more generally contribute positively to the well-being of the population and increase the productivity of the labor force. Provision of adequate district heating services is also essential. Responsibility for the rehabilitation, operation, and maintenance of municipal services has been decentralized to local governments. A key component of the assistance will be to support the decentralization process, as well as to introduce equitable cost-recovery systems, to ensure that the systems are well-targeted and financially sustainable. The regions and towns to be selected for the basic municipal services improvements will be determined considering both technical requirements and the proportion of affected people in the lower income groups. Opportunities will also be sought to collaborate with and complement the activities of other external aid agencies, such as UNDP, which has been providing TA for municipal management improvement.

124. Second, the IOS will aim to maintain and upgrade the human resource base by improving access to high-quality basic education and health care. Ensuring adequate access to education is crucial, given Turkmenistan’s young demographic profile and rapidly growing population. However, to date, external assistance to the sector has been minimal. The IOS proposes to follow a two-pronged strategy, with first, an issues-based sector review, and

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second, selected interventions that would provide targeted support to vulnerable groups as well as lay the foundation for more sustainable sectorwide reforms. The IOS will assess the potential for establishing early childhood development programs, particularly in rural areas, to better prepare young children for primary education in the formal school system. Options could be explored to optimize the use of the preschool facilities for the broader benefit of the rural communities by providing other social services, such as training programs for mothers on child care, health, and nutrition. In addition, based on the findings of the sector review, recommendations will be made for concrete interventions in basic education, being fundamental to longer-term sustainability of the education sector. Other areas to be considered include the potential for applying information and communications technology to accelerate development in dispersed rural communities, by providing access to information and knowledge in an efficient, cost-effective manner.

125. Turkmenistan has made significant improvements in the provision of effective health services. However, since independence, the health status of lower income groups remains poor. Resource constraints have reportedly resulted in public hospitals being short of equipment and supplies. Health is one of the key areas where the Government has started to introduce some reforms, with the assistance of other donors (IDB, United Nations Children Fund, World Health Organization, and World Bank). ADB could contribute to the deepening and extension of ongoing health reforms. Another objective will be to improve the access of the rural population to primary health care.

2. Sustainable Economic Growth 126. Economic growth is the most effective way to secure sustained increases in living standards. Given Turkmenistan’s rich natural resource endowments, oil and gas will likely continue to play a vital role in the country’s overall economic development. The development of energy resources is dependent on a number of external factors, including complex international arrangements for oil and gas transportation. Although the prospects for progress on these issues are good, the results will only be felt after substantial effort and time. On the other hand, development prospects in agriculture depend almost entirely on government policies and resources mobilization. The proper management of scarce irrigation resources is crucial in this regard. The IOS, with a three-year time horizon, will therefore focus on two areas of interventions.

127. The IOS will aim at capacity building to improve public sector management. In light of the continued dominant role of the public sector in the economy in the near future, an efficient system must be put in place to direct public resources to priority uses. The highest priority for initial ADB assistance is to strengthen the institutional capacity of key government agencies by enhancing the staff’s managerial and technical skills, and ensuring more efficient and effective management of public resources. Areas to be covered could include tax administration, audit systems, public procurement systems, banking and financial sector management, and public expenditure management. The National Statistics Office has requested assistance with capacity building to improve its systems for data collection, implement a system of national accounts in line with international practices, and develop linkages with policy formulation. In addition, ADB is also providing assistance to its developing member countries in regional and subregional groupings on issues of common concern, including various aspects of public sector management, through regional Tas, seminars, and conferences conducted by the ADB Institute. Turkmenistan’s active participation in such activities will provide useful opportunities for its officials for training, external exposure, and networking.

128. The IOS proposes undertaking an agriculture sector study to develop a strategy for sectoral development, including a review of Turkmenistan’s comparative advantage in the

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sector. Given that less than 4% of total land area is arable and water is extremely scarce, a careful assessment of the economic profitability of cotton and wheat production, the two main agricultural crops, should be made. Furthermore, the prospects for increased diversification of agricultural output into fruits, vegetables, and livestock should be evaluated. The proposed study will need to consider all effective costs of production, including environmental costs.

129. Environmental management will be emphasized. Sustainable utilization of natural resources, in particular, improved management of water and soil resources, should be both a medium- and a long-term strategy. A comprehensive and flexible approach should be adopted considering that this issue is multidimensional, and complex, and requires long-term efforts. Given that most of the water is used for irrigation, initiatives to integrate ecological concerns in agricultural water management will be prioritized. This could include introduction of more efficient irrigation systems; incentives to conserve irrigation water usage at the community level; and rehabilitation of the distribution systems, reservoirs; and control structures, including the Karakum main canal. Given the extensive scale of the problems and large magnitude of investment required, opportunities will be sought to collaborate with external aid agencies that have already provided support or expressed interest in this area, such as IDB, Japan International Cooperation Agency, UNDP, and the World Bank. The development of national environmental policies and capacity building should be emphasized. Opportunities of channeling Global Environment Facility funds should also be explored.

3. Regional Cooperation 130. In light of recent developments in neighboring Afghanistan, Turkmenistan can potentially play a key role in the reconstruction and rehabilitation of that country. Opportunities in the transportation and energy sectors have already been identified by the Government and discussed with ABD and UNDP.

131. The road from the town of Atamurat to the Afghanistan border at Imam-Nazar, approximately 115 km, is badly in need of rehabilitation. The road passes through the Turkmen town of Kerki and presently serves as a key route for international aid relief operations via Turkmenistan to the Afghan city of Mazar-i-Sharif. The Government has asked ADB to take up the rehabilitation work to improve the road to international standards. Its rehabilitation is therefore needed on an urgent basis. The road is a key link in the regional road network and will facilitate cross-border trade. The rural population will also benefit from the development stimulated by the improved road. Turkmenistan has also undertaken a prefeasibility study to supply the Afghan city of Herat and proximate border areas with urgently needed electric power supply. Turkmenistan’s excess power generation capacity offers a potential source of supply and the relatively short distance requires only a modest investment.

132. Longer-term efforts will be required for channeling the abundant oil and gas reserves of Turkmenistan to new export markets in South Asia, but these also promise substantial long-term rewards. With the improved conditions in Afghanistan, the most immediate prospect is the construction of a gas pipeline from Turkmenistan through Afghanistan to Pakistan and India. Given its experience in promoting subregional cooperation in Central Asia and other parts of Asia, ADB has a unique comparative advantage to support such initiatives. ADB’s involvement can help to ameliorate political risks, thereby attracting private foreign investment for these complex and capital-intensive projects. Tapping potential markets in the rest of Asia will entail much higher costs. ADB will also work to encourage and promote regional cooperation efforts on water management issues, which are likely to acquire critical dimensions even in the near future.

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C. Cross-Cutting Dimensions

1. Living Standards and Human Development 133. The IOS’s objective of raising the living standards of the people of Turkmenistan in a sustainable manner would be achieved through a two-pronged approach. First, ADB will give immediate priority to human and social development aspects. The proposed activities in the fields of education, health, and provision of basic services (water and district heating in particular) should ultimately generate significant improvements in the population’s living standards by improving the quality of life, knowledge, and eventually economic opportunities. Additionally, efforts for better public sector management would improve both the allocation of public resources and their utilization. This would enable Turkmenistan to use its considerable natural resource wealth to more effectively increase the living standards of the population.

134. Second, a special emphasis will be placed on raising rural incomes, as the vast majority of those in the lowest income quartile live in rural areas. In each of the five regions of the country, the incidence of poverty is higher in rural than in urban areas. Initiatives for raising agriculture productivity will be taken to raise incomes and encourage diversification in cropping patterns to reduce vulnerability inherent in monoculture practices and to achieve sustained growth. Providing farmers with greater income potential should enable them to better maintain water and irrigation services.

2. Governance and Public Sector Management 135. In light of the continued dominant role of the public sector in the economy, in the near term, an effective and transparent governance system is essential to direct public resources to priority uses. Good governance involves many aspects besides transparency. In the case of Turkmenistan, several long-term challenges should be addressed. First, the separation of commercial and noncommercial activities of government ministries would lead to greater financial discipline in enterprises and permit the Government to concentrate on supervision and regulation. Second, the liberalization of trade and exchange regimes would be particularly effective in eliminating the generation of rents in the system. Third, strong banking and auditing institutions will be needed in the medium to long term to support procurement and accounting practices that approximate international standards and norms. Fourth, a greater participation of civil society in the decision-making process should be encouraged.

136. The IOS will focus initially on improving the management of public expenditures. Three issues appear particularly important: transparency, expenditure priorities, and adequacy of funds for particular programs. In addition, comprehensive public sector accounts and strong financial management are needed for reliable economic forecasts that are critical for maintaining macroeconomic balances. Likewise strong financial management of public investment and external public debt is essential. All these issues will be discussed with the Government, whose ownership of the programs is crucial if they are to succeed.

3. Private Sector Development 137. Development of the private sector has a key role in fostering overall economic growth; diversifying the economy; and creating an atmosphere to attract foreign investment, especially in the energy sector. Yet, at this time, the broad macroeconomic environment is not conducive to the development of a vibrant private sector. The severely restricted foreign exchange and trade regimes and the state orders system clearly dampen private sector activity. Unless, these distortions are eliminated, the prospects for private sector development in Turkmenistan are limited. ADB will consider activities for private sector development once substantial progress in

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key policy areas such as agricultural reform and foreign exchange and trade liberalization is achieved. This would require an IOS update outlining progress on reform programs and identifying specific interventions, to be undertaken in close coordination with EBRD, which has been active in this area for several years.

4. Environment 138. The primary environmental issue facing Turkmenistan is the overuse of water to irrigate crops (cotton fields mainly) and a lack of incentives for individuals and businesses to conserve water. This overuse has increased the salinity of the soil with resultant soil degradation and reduction in crop yields. It has also contributed to the shrinking of the Aral Sea, a source of regional concern. Environmental issues in Turkmenistan are therefore very much linked to the issue of agrarian reforms and agricultural practices. The IOS proposes to address improved management of water resources at the district level, working with farmers and farmers associations.

D. Determination of Assistance Modalities and Duration of the IOS

1. Absorptive Capacity 139. In recent years, the Government has intensified foreign borrowing mainly to finance public infrastructure and construction projects. As a result, the debt service ratio increased rapidly from zero in 1993 to 98% in 1998, before declining to 55% in 1999 following a sharp increase in export revenue.24 Foreign exchange reserves have increased and were estimated at over $1.8 billion in 2000. With an increase in gas exports and improved prospects for export earnings, the Government does not appear to be concerned with the external finance situation. Although firm data on external balances are not available, the external debt and financing situation of Turkmenistan remains fragile and highly vulnerable to external shocks.

140. Turkmenistan’s absorptive capacity is limited. Public resources are managed in a less than transparent manner, with the state budget accounting for only a fraction of public resources. A large portion of public resources is collected in off-budget funds under different ministries and state enterprises, with serious risks of resource misallocation. The responsibility for external assistance is distributed among several government agencies, without a coordinating point. Furthermore, the institutional capacity for public investment planning, project implementation, and coordination of external assistance is weak, as confirmed by the experience of other external assistance agencies. In light of slower than anticipated progress of policy reforms, a number of aid agencies have recently reduced their level of activity.

141. ADB is committed to establishing a relationship of development cooperation with the Government, in order to assist and encourage reform and progress in the critical medium-term period. ADB may be able to play a role in helping the Government plan and implement needed reforms, initially focusing on a limited number of sectors. The pace of reforms is likely to be even slower without constructive engagement with the Government. At the same time, Turkmenistan’s potential key role in restoring stability and economic growth in the subregion, 24 Debt figures should be interpreted with caution, as the Government stopped publishing official debt statistics in

1998. The Government recently committed to providing IMF and World Bank with external debt statistics by the end of March 2001. IMF had otherwise threatened to impose sanctions, including possible revocation of Turkmenistan’s voting rights, due to its inability to conduct a scheduled Article IV consultation caused by lack of data on balance of payments, budget, and external debt. Similarly, the provision of such data is among the conditions set by the World Bank in its country assistance strategy for FY2001–2003 approved in January 2001, for the provision of new lending. Other conditions include resolution of the Government’s violation of the negative pledge clause, improving portfolio performance, and taking basic debt and budget reform actions, such as reforming the FERF. The Government has not yet complied with the information requests.

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initially focusing on the reconstruction of Afghanistan, provides ADB with an important opportunity for establishing a meaningful dialogue and relationship of mutual trust with Turkmenistan.

2. Assistance Modalities

a. Approach to ADB Assistance 142. ADB’s assistance to Turkmenistan will initially focus on capacity building, strengthening key institutions, and developing the managerial and technical skills of government staff, to improve public sector resources management, and the planning, implementation, and monitoring of development projects. Such support will be provided through training programs and advisory TA grants, which will be important in establishing a meaningful collaborative relationship between the Government and ADB. The range of ADB’s resources will be drawn upon, through participation in regional activities and external training and conferences convened by the ADB Institute, as well as country-level activities. The IOS envisages a tentative level of TA operations of $2.5 million per year.

143. An intensification of cooperation is anticipated, with progress on policy dialogue with the Government and as the Government becomes increasingly familiar with ADB policies and procedures. Lending operations25 could commence with projects that have direct and substantial benefits for improving living conditions in neighboring Afghanistan, These could include rehabilitation of the road network used for transport of essential supplies to Afghanistan, and power transfer from existing Turkmen facilities, to other lending activities based on the outcome of the policy dialogue with the Government on sector reform priorities and the Government’s ownership of the mutually agreed reform agenda required.

144. For sector priorities, ADB involvement will be agreed upon with the Government during the annual country programming missions, which will be undertaken following the approval and adoption of the IOS. In accordance with ADB’s strategic objectives, the prioritization criteria will be based on the extent of impact (i) on improving the living standards of the lowest income groups, (ii) on improving efficiency of public sector management, and (iii) on promoting regional cooperation. The missions will determine the specific lending and TA operations for each year of a three-year rolling plan, beginning with the subsequent year; and prepare recommendations based on a review of the Government’s evolving development priorities, the continued relevance of ADB’s IOS to address the priorities, and the progress in implementing the ongoing portfolio of projects.

b. Collaboration with Other External Aid Agencies 145. During the 1990s, funds for development assistance in Turkmenistan, both from multilateral and bilateral external assistance agencies, have become increasingly scarce as emphasis has shifted from provision of inputs to achievement of development outcomes. Several opportunities for ADB assistance have been identified, based on the potential they offer to collaborate with or complement previous and ongoing work of other external aid agencies. These include (i) TA for banking and public sector financial management with TACIS; (ii) TA to support the initial implementation phase of the new public procurement law; (iii) TA for decentralized municipal management improvement with UNDP; and (iv) assistance to improve water resources management with IDB, Japan International Cooperation Agency, and World Bank. 25 A Board paper on classification of Turkmenistan will be prepared separately to specify ADB’s lending policy. The

country is classified as IBRD-only country by the World Bank.

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3. Risks 146. Turkmenistan has a large potential for exports of oil and gas, which if properly managed can boost economic growth and generate sufficient foreign exchange resources to meet its development needs. If agreement is reached and maintained between the Russian Federation and Turkmenistan on a long-term gas delivery contract, if alternative routes are developed for Turkmenistan’s gas and oil exports, if public resources are well managed, and if progress continues to address the major constraints to private sector development, the prospects for growth and foreign exchange earnings are good. Currently, however, the Turkmen economy faces four main risks.

147. First, the economy is heavily dependent on energy exports. Oil and gas export earnings could fluctuate significantly because of price changes or because of demand changes, pipeline delivery disruption, or payment difficulties in key markets (such as Iran, Russian Federation, or Ukraine). The potential for such disruptions can be mitigated by accelerating market reforms, which will permit more diversified private sector-led growth. Especially important in this regard are agriculture sector reforms, liberalization of trade and foreign exchange regimes, and elimination of licensing and registration requirements.

148. Second, the economy is heavily reliant on water intensive agriculture in an area historically characterized by extreme water scarcity and desert conditions. Since rainfall is limited, Turkmenistan relies on extensive irrigation infrastructure inherited from the FSU. However, over time, water intensive agriculture will act to reduce yields by increasing salinization. Turkmenistan must begin to reduce water usage, this should be feasible with appropriate incentives and support, and by reordering agriculture priorities.

149. Third, the overall management of public resources suffers from a lack of transparency and predictability. In addition, the lack of reliable information on basic economic parameters such as the full budget and external debt undermines economic management. These factors weaken the basis for collaboration with foreign investors and international financial institutions. There are reportedly some other outstanding issues that have put Turkmenistan’s relationship with some IFIs under considerable strain. Measures to bring about more transparency and address these issues in improving the risk environment for ADB’s future operations are critical.

150. Fourth, growth prospects will also depend on how quickly market-oriented reforms are implemented. To obtain the benefit of private sector growth, the environment for private sector development needs to be improved, and the state needs to withdraw from commercial activities and focus on undertaking market-enhancing activities and establishing the necessary institutional framework.

4. Duration of IOS 151. The IOS will guide ADB’s lending and nonlending operations in Turkmenistan for 2002–2004. Subsequently, a full-scale country operational strategy will be prepared, based on the experience in implementing the present IOS.

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ENERGY

1. The cornerstone of the Turkmen economy is energy. For a nation of its size, Turkmenistan possesses formidable natural resources. Natural gas reserves are the fourth largest in the world, after Iran, the Russian Federation, and the United States. Total recoverable reserves are estimated at 10 to 14 trillion cubic meters (m3) according to geologic analysis of Soviet data, and 12 trillion to 21 trillion m3 by recent Western sources.1 The country has 127 fields, including 124 fields of nonassociated gas, 39 of which are developed, 11 are being prepared for development, and 74 are under exploration. Oil resources may be as high as 6 billion barrels, according to government estimates.2 Currently, of the 27 discovered oilfields, 18 are in production (15 are onshore and 3 offshore) and 9 are under exploration (3 onshore and 6 offshore). Turkmenistan also has a wide array of mineral resources that are used for producing chemicals. 2. Turkmenistan is a sizeable net exporter of hydrocarbons. Natural gas is the dominant export and the Government’s most important source of revenue with an annual production capacity of more than 80 billion m3, most of which is for export. Oil reserves are not as significant, but this potential is still relatively underdeveloped and offers substantial production and export earnings over the long term. 3. On the domestic market, energy is heavily subsidized. Gas is effectively free to the vast majority of residential consumers as the price charge is Tmm7 per 1 m3. The price to commercial enterprises is about Tmm45/m3 or about $8/1,000 m3 at the current official exchange rate (or $2/1,000 m3 at market exchange rate). Only a proportion of industrial consumers actually pay for their gas consumption, partly due to lack of metering, and also because many customers are exempt. A poor collection system exacerbates the situation. Electricity is provided free to private households for up to 35 kilowatt hour (kWh)/person per month. For household consumption above this limit and all consumption to nonindustrial customers and state-owned enterprises, the price is Tmm48 /kWh, approximately $0.01 at the official exchange rate (or less than $0.25 per kWh at market exchange rates). Trade and commercial enterprises pay about twice this price. Electricity meters are not widely used, especially outside the main cities. As a consequence, most household consumption is free. Gasoline costs about Tmm400 per liter, approximately $0.08 per liter at the official exchange rate or less than 2 cents per liter at the market rate.

4. While Turkmenistan’s gas industry holds tremendous promise, major obstacles stand in the way. First, the country’s ability to develop its vast gas and oil resources is complicated by geography. The country is landlocked and hence must develop an export pipeline infrastructure to link its resources to external markets. This will necessitate finding reliable partners for both right-of-way access through neighboring states and foreign firms to construct potential pipelines. Currently, Turkmenistan must rely almost entirely on the Russian pipeline network and a pipeline link to Iran to export its oil and gas. This heavy dependence on the Russian pipeline system has impeded developments and foreign investments in the sector, as the Russian Federation allows Turkmenistan to export only to the Ukraine and the Transcaucasian nations, many of which have serious payments problems. In addition to the question of export routes, the five nations surrounding the Caspian Sea—Azerbaijan, Iran, Kazakhstan, Russian

1 Of this, 1.3 trillion to 2.8 trillion m3 are proven reserves, while probable and possible reserves are estimated at about

1 trillion and 17 trillion m3, respectively. 2 The proven recoverable oil reserves amount to 1.8 billion barrels (240 million tons), probable reserves to about 0.8

billion barrels (110 million tons), and possible reserves to about 40 billion barrels (5,300 million tons).

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Federation, and Turkmenistan—have for many years disputed the claims to the resources in the seabed. The main outstanding issue is the disposition of the Serdar/Kyapaz oil and gas field, which straddles the median line between Azerbaijan and Turkmenistan. 5. Given the country’s rich natural resource endowments, oil and gas exports will continue to play a critical role in the country’s economic development. The authorities, however, recognize the need to make contingency plans in case gas exports remain disrupted. One pillar of this approach has been to encourage development of the nongas sector, in particular oil refining and processing, and electricity generation. The second pillar of this approach has been to accelerate the rate of construction of the energy infrastructure, in particular gas and oil pipelines, in an attempt to stabilize exports to world markets. 6. In the oil sector, while so far limited quantities of crude oil have been exported, oil derivatives are the third largest export product of Turkmenistan. Over the next 10 years, crude oil extraction volumes are expected to quintuple to almost 50 million tons per year by 2010. The Government is also modernizing and expanding the country’s two oil refineries, located at Turkmenbashi and Turkmenabad, to meet the expected increase in oil production and demand. In recent years, the Turkmenbashi refinery has been upgraded and modernized, with financing from German and Japanese sources. Meanwhile, a new lubricant blending plant is being constructed in Turkmenbashi and is expected to be completed in 2001. 7. As for the power supply industry, Turkmenistan has excess electricity generation capacity. The total installed power generating capacity is currently 2,700 megawatt (MW). 2,652 MW are installed over seven separate power plants, while the remaining capacity consists of more than 600 small-scale generating sets. All large and small generators are owned by the Turkmenistan State Power Corporation (KUVVAT). The power system is managed under the five velayats. Dashovuz is the only velayat of the five that does not have a power plant. All these power plants are connected to the integrated electricity grid network. The best plants were only operated on a capacity factor of less than 50% in 2000, indicating availability of excessive spare plant capacity in the country at present. However, insufficient resources were spent in the last 7–10 years to maintain the power plants, most of which are 20–30 years old. Thus, extensive rehabilitation will likely be needed if the plant capacity is to be made fully available. Nonetheless, Turkmenistan has the potential to boost its electricity exports. In May 1998, the Government announced that a new power transmission line would be extended from Belek to the Iranian border enabling Turkmenistan to export up to 3.5 billion kWh to Iran annually. Turkmenistan and Iran also signed an agreement on the export of Turkmen power to Turkey via the Iranian grid in July 1999. Supplies were expected to commence in winter 2000. Turkmenistan also concluded an agreement with the Taliban authorities in Afghanistan in July 2000 for the supply of electricity to the western Afghan city of Heart. The project requires construction of two transformers and required transmission lines to export power from the Syrhetabad power station to Heart and neighboring regions. This proposal has also been suggested for Asian Development Bank (ADB) funding. 8. The second pillar of Turkmenistan’s strategy to strengthen its energy infrastructure is to develop alternatives to the Russian pipeline network. A 200-kilometer gas export pipeline from Korpedje in Turkmenistan to Kurtkui in Iran was opened in late December 1997, as the first pipeline in Central Asia to bypass the Russian Federation. The projected annual capacity was a fairly small 8 billion m3, and in 1998 and 1999 it was running well below that, at about 5 billion m3 per year. The pipeline was primarily intended to support gas exports through the Iranian grid to Turkey, but prospects for this have been clouded by the fact that Iran also wants to export

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gas to Turkey, and Iran will have much more gas available once its South Pars field is fully developed. The most important proposed project has been the TransCaspian gas pipeline, which would run from Turkmenistan under the Caspian Sea to Azerbaijan, through Georgia and deliver its gas supply to Turkey. The pipeline ran into problems in 2000, however, when Turkmenistan’s requests for higher gas prices and advance payments were rejected by the consortium backing the project. In June 2000, two of the main partners announced that they were suspending their efforts to push the project forward. A third possible route for Turkmen gas exports is a pipeline stretching from Turkmenistan to Pakistan and possibly India via Afghanistan. Construction was scheduled to start in 1998, but financing could not be secured given the risks involved due to the unstable political situation in Afghanistan. Finally, another proposal is a 6,700-kilometer gas pipeline running from Turkmenistan to the People’s Republic of China (PRC) and possibly on to Japan. In September 1998, a final deal between Turkmenistan and the PRC was delayed due to unfavorable results from a preliminary feasibility study. The presidents of the PRC and Turkmenistan discussed the issue again during a meeting in Ashgabat in July 2000, and the China National Petroleum Corporation signed a preliminary agreement with Turkmenistan for natural gas supply. However, when or if any concrete action will take place to implement the plan is still unclear. Hence, at least for the foreseeable future, Turkmenistan’s options seem rather limited and the country has no choice but to continue to depend on the Russian Federation for its energy export. 9. To promote development in the energy sector, the Government recognizes that it must attract foreign investments. Turkmenistan is actively seeking the involvement of large energy multinational corporations with promises of access to its oil and gas reserves. In 1996, President Niyazov reorganized the energy sector, with the formation of Turkmenneft and Turmengas, the state oil and gas companies. In 1997, a new petroleum law was introduced to regulate and standardize foreign participation in the sector. This new production-sharing legislation created the basis for a more transparent legal structure and improved prospects for foreign investment in the sector. 10. Oil production, from both on- and offshore fields, the commercial use of associated gases in oil production, and the development of the service sector linked to upstream and downstream activities are all areas that could attract foreign interest. Foreign investments to date include exploration and development of offshore oil fields by Dragon Oil of Ireland, which has invested $125 million since 1993, and Petronas of Malaysia, which has invested over $60 million since 1996. In 1998 Mobil Oil of the US and Monument Oil of the United Kingdom signed a production sharing agreement to develop an oil field in western Turkmenistan, in which they have invested $40 million, and both companies have plans for substantial investments. The Chinese Oil Corporation has invested $14 million in restoring and overhauling 30 oil wells. 11. Yet, some issues remain that could substantially limit foreign interest and involvement. The most important one deals with the heavy regulatory framework. First, while the Government seems eager to attract foreign investment, it remains unclear how much control the Government plans to relinquish. Second, the status of the newly created state companies remains unclear. They retain operational and regulatory functions, maintain largely untransparent fiscal relations with the central government, and are effectively run like a ministry. A major challenge for the country is therefore the corporatization of these companies, and the establishment of transparent profit taxes for the energy sector. Existing foreign participants complain about lack of transparency and predictability of their treatment, and some of the large companies mentioned in para. 10 have postponed their planned activities. Doubts about Turkmenistan’s reform commitment may further prospects for foreign investment.

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12. Currently, the oil and gas industry consists of five state enterprises. Turkmenneftgas handles the export, domestic sale, and distribution of gas, as well as oil refining, domestic gasoline distribution, and the export of oil and oil products. Turkmengas operates in the eastern part of the country and is engaged mainly in gas production. Turkmenneft produces primarily oil in the Western fields. Turkmenneftegasstroi is the primary construction company for the sector, while Turkmengeologia is responsible for the determination of hydrocarbon and other natural reserves. Turkmengas and Turkmenneft employ foreign companies as contractors. A few foreign companies currently produce oil through production-sharing agreements, others explore fields, and foreign contractors manage the gas export pipeline projects. The upgrade of the Turkmenbashi refinery has also been carried out by foreign firms. Nonetheless, the Government envisions that the state enterprises will continue to play a key role in the sector. 13. The Government controls the energy sector tightly. It taxes a large share of the revenue, decides on development priorities and policies, regulates the sector, and is involved in operational management. The sector is under the close supervision of the President and key decisions become effective only when a presidential decree is issued. The exact limitations of each of the relevant bodies are unclear, but their primary responsibilities are known to be the following: strategic planning and key decisions including export pricing policies and domestic prices are made by the Cabinet of Ministers, where a deputy chairperson is responsible for the sector. The State Fund for the Development of Oil and Gas receives a large share of revenues from the sector, and directs investments in the sector. The Competent Body for the Exploitation of Hydrocarbon Resources of the President of Turkmenistan is the key intermediary for foreign investment in the sector. It negotiates and approves licenses, and enters into exploration and production-sharing agreements. The sectoral ministries and the state enterprises (whose heads have ministerial ranks) are subordinates of the Cabinet of Ministers. The Ministry of Oil and Gas has only a supporting role in the development of sector strategies. The Ministry of Energy and the state enterprise KUVVAT are responsible for electricity production and distribution. 14. Basic legislation is in place to provide a framework for foreign investment, including the Law on Hydrocarbon Resources. Moreover some countries have signed investment protection agreements. Multiple companies operate under production-sharing agreements. Previously, all production-sharing agreements were individually negotiated, but recently a standard contract has been developed. No details on the term of production-sharing agreements are available, but estimates suggest that the Government aims at obtaining 50 to 60% of the net revenues through a combination of signing bonuses, royalties, equity shares, taxes, and production shares. Taxes on foreign producers operating under the petroleum law are paid to the State Fund for Oil and Gas Development. 15. The Government needs to take prompt action to address these concerns and reverse the perceptions that affect foreign investment in the energy sector. More broadly, the institutional structure of the energy sector in Turkmenistan needs attention. At present, it suffers from a number of weaknesses. These include, although this is achieved to some extent with the policy direction being given by the President’s office: (i) limited competition in the energy sector and lack of opportunities for new entry, reducing access to new investment and limiting incentives to increase efficiency; and (ii) overreliance of the various state concerns on government funds. In addition, the commercial performance of state enterprises in the energy sector is a significant concern. The primary reasons for this include (i) a lack of commercial focus, in large part because of social obligations and other noncore activities undertaken by the energy enterprises; (ii) domestic energy prices that are far below production and distribution

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costs; (iii) poor accountability of the management of finances and investments in the sector; (iv) poor operating practices and technology, leading to inefficiency and low productivity; and (v) lack of skilled staff and project management expertise. To address these institutional concerns, the Government needs to develop and implement a program that should include (i) a marked improvement in the commercial performance of the state-owned enterprises in the energy sector, (ii) elimination of the role of state funds, (iii) a transition to private ownership of these enterprises, (iv) establishment of regulations and a regulatory agency to oversee the sector, (v) liberalization of energy prices, and (vi) introduction of international accounting standards.

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AGRICULTURE

1. Turkmenistan is a predominantly desert country, and the total arable area amounts to only to 4.0% of total available land. Water is scarce and most of the water used for irrigation comes from the Amu Darya River through the Karakum Canal. Despite these limitations, agriculture is the second most important sector in the economy, both as an important source of employment (48% of the labor force was employed in agriculture in 1999) and export earnings (about 20% of export revenues in 2000 were derived from cotton). Yet, agriculture contributes only about one quarter of gross domestic product (GDP), suggesting perhaps that labor productivity in agriculture is lower than in other sectors. 2. The two major crops, wheat and cotton, are produced and marketed under a state-order system.1 Under the state order system, the Government sets procurement prices and production targets (Table A2.1). The state also provides inputs at subsidized prices and credit at zero or markedly below-market rates. Producers of wheat and cotton under state-order contracts are entitled to receive a 50% subsidy on purchases of fertilizer, chemicals, fuel, transport, machinery services, and other purchased inputs. Producers also receive a 30% advance payment on contracts for cotton and wheat, with the remainder payable upon delivery. In addition, producers do not pay for irrigation services and water. In principle, these subsidies are supposed to offset the implicit taxation of low producer prices. In practice, the quantitative flows are difficult to measure, since producers do not necessarily pay for inputs at the time of delivery, or receive payment for output upon delivery.

Table A2.1: State Procurement — Cotton and Wheat Production and Prices (1993–2000) Item 1993 1994 1995 1996 1997 1998 1999 2000Cotton Production Target ('000 tons) 1,500 1,400 1,400 1,500 1,300 1,500 Actual Production ('000 tons) 1,341 1,283 12,394.40 435.5 635.2 704.9 1,304.10 1,031 Procurement Prices (Tmm/ton) 100,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Procurement Prices ($/ton) a 500 246 240 192 192 192 Procurement Prices ($/market price) 47.2 Export Price (fiber, $/ton) b 1,009 849 1,632 1,447 1,354 1,179 World Market Price (fiber, $/ton) 1,279 1,757 2,167 1,776 1,747 1,445 1,171 1,302

Wheat Production Target ('000 tons) 1,000 1,150 1,200 1,200 1,300 1,500 Actual Production ('000 tons) 509 712 878.7 453.1 707 1,229.40 1,510.60 1,705.30 Procurement Prices (Tmm/ton) 38,000 143,000 400,000 400,000 400,000 400,000 Procurement Prices ($/ton) a 190 35 96 77 77 77 World Market Price ($/ton) 212 230 160 163 151 147

Memorandum Item: Official Exchange Rate (manat/$) 3 75 200 4,070 4,165 5,200 5,200 5,200Market Exchange Rate – 20,850 21,000– = not available. a Manat price converted at official exchange rate.

b Average unit value of exports.

Source: FAO Statistics. EIU Country Profile 2000/2001.

1 Rice and sugar beets are other state-order system crops, but the volumes produced are small so far.

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3. The main organization for marketing cotton is Turkmenpahta, whose main functions are purchasing raw cotton from farmers, operating ginneries, and selling cotton fiber to foreign buyers. Turkmenpahta is also responsible for producing and supplying seeds to farmers, and providing fertilizers, as well as technical advice to producers on production and irrigation processes. For wheat, the system is administered by the Turkmen Bread Association. The association provides seeds and fertilizers to farmers; owns mills, storage facilities; and shops; and participates in each stage of the production and distribution process. The announced goal of the state order system for wheat is to ensure self-sufficiency, as well as to provide bread to large groups of the population at subsidized prices. 4. The agriculture sector shrank in the initial years following independence. Agricultural output decreased by a cumulative 28% during 1993—1996, primarily due to a large reduction in cotton production. In 1996, the cotton crop amounted to only 437 thousand tons, less than a third of 1993 levels. This decline was due to a small reduction in the amount of land devoted to cotton (Table A2.2), but most importantly to drought conditions and a near breakdown in the organizational structures as a result of transition from state farms to farmers associations. These difficulties led to a large decline in raw cotton production yields which were only 1.2–1.3 tons per hectare in 1998, compared with an average of 2.3 tons per hectare in 1990–1995 (in the People’s Republic of China, for example, yields per hectare were 3.2–3.3 tons in 1998). Since 1997, cotton production has improved steadily and by 1999 was almost back to 1993 levels with yields around 2.3 tons per hectare, according to official reports.2 (Table A2.3).

Table A2.2: Land Sown to Main Crops, 1992–2000 (‘000 hectares)

Vegetables Feed Crops/ Total Year Cotton Wheat and Melons Coarse Grain Arable Land 1992 567.0 195.5 53.6 209.6 1,249.0 1993 579.0 260.0 78.9 265.7 1,495.7 1994 557.0 431.6 49.1 248.1 1,605.8 1995 563.0 552.2 46.5 220.1 1,628.4 1996 530.0 536.0 43.6 193.5 1,635.3 1997 482.0 510.6 35.4 168.3 1,643.2 1998 548.1 678.1 31.6 93.9 1,602.8 1999 621.1 727.0 30.1 79.4 1,623.4 2000 619.0 741.0 24.8 62.6 1,642.7

Source: FAO Statistics.

5. Under the Government’s programs for achieving self-sufficiency in food grains, land allocated for wheat production increased after independence from 195.5 thousand hectares in 1992 to more than 741 thousand in 2000. About 1,700 thousand tons of wheat were produced in 2000, more than 200 thousand tons above the target set under the state-order system. Increased wheat production has reduced imports for wheat and flour. Reportedly, the authorities are planning to increase wheat production to about 3 million tons by 2010. Yields per hectare

2 Official figures are questioned by private observers and industry sources who actually paint a much darker picture.

For example, they peg actual cotton production at only 620 thousand tons in 2000 against an official figure of 1,031 thousand tons. This is reportedly attributed to a severe drought that plagued the region for the past couple of years.

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have remained low, below 2.6 tons per hectare from 1992 to 1998. According to official sources, yields have improved over the past couple of years reaching slightly above 3 tons per hectare.3

Table A2.3: Production and Yield of Cotton and Wheat, 1992–2000

Year Production ('000 tons) Yield (tons/ha) Cotton Wheat Cotton Wheat

1992 1,290 377 2.27 1.91 1993 1,341 509 2.32 1.96 1994 1,283 675 2.29 2.58 1995 1,293 695 2.13 1.59 1996 436 453 0.84 0.76 1997 635 707 1.09 1.42 1998 707 1,245 1.22 2.49 1999 1,300 1,506 2.37 3.17 2000 1,300 1,700 2.26 3.09

ha = hectares Source: FAO Statistics

6. The area allocated to other crops that are outside the state-order system has declined since independence. These crops include grapes, melons, corn, potatoes, and other vegetables. Turkmenistan was a traditional supplier of fruits and vegetables to other former Soviet Union (FSU) republics, but that market has now collapsed. The sharpest decline has been in animal feed crops, which appears to be an anomaly in the light of reported increase in livestock and decline in imports of animal feed. Although other crops and livestock are not marketed within the state-order system, the state can still influence decisions in these sectors through land allocations, implicit price controls, and availability of inputs. 7. Most farms (comprising two to three people) belong to farmers associations, which are in charge of managing farming on large-scale fields. Farmers associations replaced the Soviet state and collective farms but remain similar in structure. They have a right to lease land and organize “brigades” from individual households. The budget of these associations is financed by a 12% tax from the proceeds of individual farmers. Major processing plants for meat, milk, and horticultural products remain publicly owned. Local governments in some cases require processors to provide milk and meat under preferential terms to schools, hospitals, and other local institutions with special status. This implicit price control on a portion of processed products depresses the prices that processing plants can pay for raw materials. As a result, most meat and milk is sold on local markets and fully bypasses the processing sector. Most cattle and a large number of sheep and goats are in the household sector, and can be marketed informally and directly (Table A2.4).

3 These reports are disputed by private industry sources, which estimate wheat yield averages at only about 1.5 to 2

metric tons per hectare. (For reference purposes, wheat yields were 3.7 tons/ha in the People’s Republic of China and averaged around 7-8 tons/ha in Western Europe in 1998).

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Table A2.4: Livestock—Herd and Production, 1992–2000

Year Cattle Sheep and goats Slaughter Weight Milk Milk Yield ('000 heads) ('000 heads) (meat '000 tons) ('000 tons) (kg/cow)

1992 777.0 5,600.0 98.0 471.0 1,308.3 1993 1,004.0 6,265.0 109.0 712.0 1,711.5 1994 1,104.0 6,314.0 107.0 715.0 1,499.0 1995 1,181.0 6,503.0 110.5 727.3 1,359.4 1996 1,199.0 6,574.0 111.9 754.8 1,331.2 1997 959.0 5,775.0 110.1 755.4 1,573.8 1998 950.0 5,870.0 129.0 765.3 1,577.9 1999 880.0 6,025.0 133.6 875.4 1,750.8 2000 850.0 5,968.0 134.3 900.0 1,764.7

Source: FAO Statistics. 8. The state in Turkmenistan is actively involved in allocating and distributing of fertilizer, seeds, agricultural chemicals, machinery, and fuel. In contrast, the private sector is relatively undeveloped and inactive in provision of inputs. Imports of fertilizer and chemicals are managed through the State Agency for Foreign Investment, and then distributed through a subsidiary firm associated with the exchange. 9. Turkmenistan inherited a well-developed and innovative system of biological pest control from the Soviet system. The system consisted of a network of laboratories producing biological plant protection agents. The system declined throughout the 1990s, but interest was renewed following the crop failure of 1996 and subsequent outbreaks of pests. In 1998 the Government began a program to revive the system and has made modest progress to that effect. Services for the crop and livestock sectors (primarily plant protection and veterinary services) are now on a cost-recovery basis, although the extent to which payment can be collected is still to be tested. 10. The state pays virtually the entire cost of maintaining and operating the irrigation system. Overall, investment in essential public goods and services for agriculture is low. Basic maintenance of the irrigation system, investments in agricultural science, and extension activities have been cut back severely since independence (in 1999 only 2.1% of public investment was devoted to agriculture against 14.4% in 1994, according to official statistics). Public investments related to agriculture have been largely to support the Government grain program, including grain milling capacity, and importation of combines for harvesting. The policies and programs pursued in the 1990s have thus resulted in a significant depreciation of the capital stock in primary production and water management. Private investment in agriculture is low (because earnings are low), and limited to the household plot (since this is the land for which families have the greatest chance of securing tenure). One of the potential advantages of transferring agricultural land to private ownership would be to stimulate private investment in rural areas, as households invest to improve and utilize their enlarged landholdings. 11. The Government has initiated the policy of transferring land to private ownership at the end of the lease period or even earlier if performance is deemed satisfactory. Each household can hold up to an average of 50 hectares of land. They can choose the crops to be produced but receive the support of the farmers association only if they abide by the Government’s schemes for producing strategic crops on at least half the holding.

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12. Throughout the 1990s, the financing of agriculture in Turkmenistan has involved large and complex flows into and out of the budget, the banking system, and various off-budget funds. Financing to farmers is provided by Daykhan Bank, which provides credit to individual farmers at the subsidized rate of 2% per year. The loans are to individual leaseholders and are secured by personal property. Dayhanbank is also the major financing channel for procurement at harvest. Dayhanbank's resources are relatively modest, and insufficient to finance large-scale procurement of the wheat and cotton harvests. Hence, the state ultimately provides financing to purchase the crop. In 1998, financing appears to have come from a special emission of directed credit issued by the Central Bank of Turkmenistan at the end of the year and distributed through Dayhanbank. 13. The Asian Development Fund is mainly responsible for financing subsidies for current inputs, such as fertilizers. The fund is financed mainly by the sales of cotton fiber, which are allocated to the fund at the discretion of the President. About a third of cotton revenues go to the Foreign Exchange Reserve Fund with the remaining being divided between the Asian Development Fund and the budget. The raw cotton is purchased at the farm gate (at very low fixed prices) by Turkmenpahta, which then processes and sells the ginned products mainly for export at much higher prices. The processing stage is subject to the value-added tax and standard corporate profits and property taxes. Growers must also pay the negligible land tax. While cotton is implicitly taxed at a very high rate, other agricultural products are virtually untaxed. The 8% tax levied on farmers associations was abolished in 1998 and the sector is largely exempt from value-added tax or enterprise profit tax. The new land tax is minimal. 14. Overall, the institutional setting for agriculture in Turkmenistan remains fairly administered. With some landholdings being transferred to private ownership, and expansion of livestock and nonstrategic crops on household plots, the private sector has made some advance in agriculture in recent years. Producers of cotton and wheat are subject to rules for production, marketing, and pricing that result in a high level of implicit taxation of their potential earnings. The combination of weak development of the private sector and poor incentives for agricultural production will reduce the willingness of rural people to invest in land, even if they are granted secured tenure. Therefore, the land reform currently under way needs to be accompanied by institutional arrangements for input supply and marketing, as well as changes in price policy to have a strong impact on the enthusiasm with which rural people seek land ownership and to stimulate investment to the land. 15. Some progress is envisioned under the National Program of Socio-Economic Development up to 2010. For example, the Government envisions a reorganization of the processing sector to increase the scope for private ownership and investment. Furthermore, the Government intends to accelerate land reform and increase the number of private landowners. However, the key crops are to remain under state control. And the Government envisions an ambitious increase in the production of both wheat and cotton, roughly doubling over the next 10 years. This is to be achieved both through an increase in areas sown (by over 40%) and an improvement in yields. To help rehabilitate cropland, the President has initiated a project (estimated at around $6 billion) to build an artificial lake in Northwestern Turkmenistan, in the Karakum desert, to collect field run-off from across the country. The runoff will be channeled across the country in unlined canals to accumulate in a depression. The runoff will then be desalinated, cleaned, and purified before entering into the lake. The project, which is supposed to span over 10 years has three main objectives: to clean up the existing water sources by diverting the pesticide-laden waters from returning to the Amu Darya River or the Karakum

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canal; to provide new croplands; and to provide entertainment and water sporting opportunities to the Turkmen people.

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HEALTH

1. The Turkmenistan Presidential Health Program, issued in 1995, emphasizes the need to (i) develop family doctor practice and primary healthcare, (ii) rationalize health services, (iii) improve the quality of care, and (iv) strengthen the health financing system. Under this framework, the Government has embarked upon major health reforms, including health financing (establishment of medical insurance), allocation mechanism (shifting resources to primary health care from hospital-based care), and service provision (creation of and shift to family doctor practice). The program represents an important recognition of the need for a systematic approach to health sector reform, and the Government has taken steps to stimulate much-needed improvements in service delivery and to ensure better use of resources in line with needs. While it is still early to evaluate the outcome of these reforms, official data indicate that improvements in recent years have been significant in basic health indicators, such as maternal and infant mortality rates and life expectancy. Verifying continuation of this trend over the next couple of years will be important. 2. Health services in Turkmenistan still remain mainly curative rather than preventive and primarily based on hospital care. The health service delivery system consists of a hierarchy of feldsher stations; ambulatory centers; and district, regional, and national hospitals. In 1998, there were 148 hospitals countrywide, including small-sized rural district hospitals. The first private hospital opened in 1999 and a number of self-financing units at public hospitals provide care outside the national basic benefits package. In 1998, there were 6 beds per 1,000 population (compared with 11 in 1993). The hospitalization rate was high (12.6% of the visits were hospitalized), and the average length of stay was extremely long (12 days). There were 3 physicians and 8 nurses per 1,000 population. Both figures are high (higher than the Western average), especially of specialists, leaving general practice and basic public health needs unmet. 3. The administration of the public health system, inherited from the Soviet system, has been fully revamped during the past 10 years. With help from a number of external agencies, including the World Health Organization, the Government has attempted to establish a modern public health system that is based on universal access, efficiently using scarce resources and a medical insurance system that was introduced for the entire population in 1999. The Ministry of Health and Medical Industry (MOHMI) of the central government bears the responsibility for policy formulation, maintenance of minimum standards and quality of medical services, and the planning and organization of medical services in the country. Under its supervision, the responsibility for delivering health services lies mainly with the regional health authorities. These regional health authorities have a dual reporting structure, with both the provincial governors and MOHMI having oversight functions. The budget for these regional authorities is provided directly by the Ministry of Finance (MOF) and is disbursed by the provincial government. Eighty-six percent of the total budget of the health sector is allocated directly to the regional authorities. MOHMI exercises quality control and is responsible for personnel and organizational issues. The dual track could result in some dilution of responsibility and confusion. Reportedly, the Government is now considering a change to direct funding of the district health centers through MOHMI. Despite some improvements, initiated largely by MOHMI, allocation of resources from MOF is largely based on past practices norms that still emphasize maintenance of physical assets rather than encourage efficiency and quality of medical services.

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4. Universal access is one of the main advantages inherited from the Soviet era. Indeed, physical access is excellent due to the large number of facilities. Eighty-nine percent of the urban population and 69% of the rural population have access to polyclinics within one hour. There is some overstaffing and inefficient use of facilities as reflected in lengthy stay at hospitals that reportedly occurred due to ineffective treatment (lack of skills, drugs, and equipment). Salaries of health workers, although higher than the average monthly wage level in the country, are still fairly low. This may lead to skills moving out of the sector in coming periods. Training opportunities have been skewed due to lack of funds. The physical infrastructure of medical education institutions is poor, although ad hoc funding is made available through the State Health Fund and other off-budget accounts. Self-financed institutions and departments for employment of additional medical personnel are being established. User fees were introduced in 1998 for some diagnostic and treatment procedures, but remain fairly rare, and account for less than 1% of revenue. Unofficial payments to physicians and other health care providers are reported to be widespread. 5. Turkmenistan’s health indicators (such as life expectancy, infant mortality, and maternal mortality) were historically among the worst in the FSU countries (Table A3). Infant mortality in 1994 was 46/1,000, compared to 27/1,000 in Kazakhstan, 29/1,000 in the Kyrgyz Republic, 28/1,000 in Uzbekistan, and 41/1,000 in Tajikistan. The high maternal and infant mortality rates were probably related mainly to poor obstetric care and high fertility levels, although the rate of infant mortality may also be related to poor quality water and sanitation, diarrhea, and acute respiratory infections. The low level of life expectancy is attributed to the high infant mortality rate and also to the considerable amount of premature death caused particularly by cardiovascular diseases. According to official figures, improvements in both maternal and infant mortality rates in recent years have been substantial. The figures in 2000 are reported to have been 47/10,000 and 21.4/1,000 respectively. The vaccination coverage of children up to 14 years of age has also increased from 94% in 1997 to 98% in 1999. In addition, decline in several types of infectious diseases have been reported (such as blood circulation diseases, respiratory diseases, and genitourinary diseases). On the other hand, the incidence of tuberculosis has increased in recent years. The main reasons for this may be malnutrition, unemployment, housing problems, increased drug abuse, and inadequate treatment due to drug shortages. Overall, however, life expectancy is apparently showing signs of improvement. The latest figures released by the government report the life expectancy rate as 68.3 years in 2000. 6. Shortage of cash in the public health care system is often reported as a chronic problem. Although health care services are meant to be free, medicines and basic medical equipment (such as syringes) are in severe shortage, and patients often have to buy them themselves in order to get services. Adequate access to care to the most disadvantaged must be ensured. Public health care spending per capita was reduced to about $9 in 1996, from $20 in 1994. While the Government has made efforts to level or even reverse this trend in recent years, e.g., public spending on health as a share of gross domestic product (GDP) was increased from a level of 2% between 1992 and 1994 to 4% in 1998, spending has actually decreased in real terms due to the significant drop in GDP experienced between 1991 and 1998. The Government has introduced several programs in an attempt to generate additional revenues.

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Table A3: Health Indicators for Selected Central Asian Republics, 1990–2000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 a

A. Life Expectancy, number of years KAZ 68.8 – 69.6 69.7 67.5 67.5 – 67.6 67.9 64.4 – KGZ 68.8 – 69 69.2 67.8 67.9 – 67.6 68 67.4 – TAJ 69.6 – 70.2 70.4 66.8 66.9 – 67.2 67.5 67.4 – TKM 66.4 – 65 65.1 64.7 64.9 – 65.4 65.7 65.9 68.3* UZB 69.5 – 69.2 69.4 67.5 67.5 – 67.5 67.8 68.7 –

B. Maternal mortality rate, all causes, per 100 000 live births

KAZ 75.8 48.1 57.2 49.4 48.4 57.6 52.9 76.9 77.5 65.3 – KGZ 81.4 76.4 70.1 80.1 80.1 67.4 65 76.4 54.7 46.1 – TAJ 97.7 101 120 124 122 97.7 84.5 64.6 66.5 53.9 – TKM – – 132 105 98.8 99.5 105 71.6 64.5 41.2 47.0* UZB 73.2 65.3 51 40.6 38.6 32.2 20.7 10.5 9.6 14.6 –

C. Infant mortality rate, per 1000 live births

KAZ – 27.3 25.9 28.1 27.1 27 25.4 24.2 21.4 20.2 – KGZ – 29.7 31.5 31.9 29.1 28.1 25.9 28.2 26.1 22.7 – TAJ – 40.6 45.9 47 40.6 30.6 29.1 27.6 23.4 19.4 – TKM – – 44.5 45.9 46.4 42.2 40.5 37.8 32.9 25.4 21.4* UZB – 35.5 37.4 32 28.2 26 24.2 22.8 21.9 20.2 – – = not available, KAZ = Kazakhstan, KGZ = Kyrgyz Republic, TAJ = Tajikistan, TKM = Turkmenistan, and UZB = Uzbekistan. a Figures for 2000 are from recent government reports and may not be comparable to those for the period 1990-1999 due to

differences in compilation techniques, assumptions, and data sources. Sources:

For life expectancy, UNDP (1990-2000), Human Development Reports. Washington. For maternal mortality rate and infant mortality rate, WHO Information Center on Health for Central Asian Republics.

7. The Government introduced a government-run voluntary medical insurance system in January 1996. The insurance covers about 6% of total health spending. Almost the entire population is eligible under this scheme, either as members or as dependents. The scheme already faces financial difficulties, due to premium collection problems, a large family size (5.6 on average compared with 3.5 in other Commonwealth of Independent States republics) and larger pharmaceutical demand (e.g., the number of drugs covered by the scheme has increased to 500 from 120 following public pressure). The Cabinet of Ministers is currently considering a new health insurance law that would make medical insurance compulsory. Since March 1996, commercial pharmacies are also permitted under a new regulation by MOHMI, but privatization has moved slowly so far. A serious shortage of essential drugs plagues the country at all levels. 8. Since independence, external assistance has been provided to the health sector. The governments of Pakistan and the People’s Republic of China have approved credits for the supply of drugs, United Nations Children Fund (UNICEF) and bilateral assistance agencies supply vaccines, and an Indian joint venture for the local production of pharmaceuticals was established in 1997. Turkish International Cooperation Agency, United Nations Development Programme, and World Health Organization are supporting the Lukman Health Program, aiming to strengthen the capacity of MOHMI. In addition, the World Bank prepared a $9 million project to improve the quality of care and efficiency of health care delivery in a pilot district. However, the project was never implemented as the World Bank suspended all its activities for almost 2

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years due to macro policy disagreements and financial problems with the Government. Other assistance includes diarrhea disease control by UNICEF, contraceptive supplies, and family planning training by United Nations Population Fund, and overseas training of health staff in healthcare management by the United States Agency for International Development. The preliminary outcome of these efforts seem to be positive, as basic health indicators seem to have improved significantly over the past couple of years. However, these reforms must be supported and deepened if the recent improvements are to be sustained. In particular, more needs to be done to ensure equal access and quality of services, especially in rural areas.

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ENVIRONMENT

1. The key environment development challenge the country is facing is the deterioration of water and soil resources, particularly the increasing levels of soil salinity, soil erosion, and declining water quantity and quality. Compared with the problems of natural resources degradation, industrial and urban pollution problems are currently less pressing due to the relatively slow process of urbanization and declining industrial production since independence. 2. The issue of soil and water degradation is very complex. Turkmenistan is almost entirely dependent for both drinking and agricultural water on the Amu Darya, a river which travels from Tajikistan through Turkmenistan and Uzbekistan to the Aral Sea in Kazakhstan.1 With 95% of water used for irrigated agriculture, Turkmenistan has built an extensive network of irrigation canals channeling water from Amu Darya to its plains and oases. The largest is the 1,100 km Karakum Main Canal (KMC). The nature of the transboundary water system determines that the long-term solution to effective water management in Turkmenistan will depend on not only the country’s own efforts but also regional cooperation among the Central Asian republics (CARs). This has made the water issue in Turkmenistan more challenging and complicated, given the predicable difficulties and uncertainty in terms of bargaining costs, which could prevent the gains from joint management to be achieved.

3. The most urgent issues requiring regional cooperation for long-term solutions are the ecological disaster of the Aral Sea and sedimentation problems in downstream countries. Turkmenistan has contributed to and suffered from the consequences of ecological damage to the Aral Sea. Excessive irrigation in Turkmenistan and elsewhere in Central Asia contributes to the desiccation of the Aral Sea,2 which in turn adversely affects land productivity and the health of the population residing in the Aral Sea regions. For examples, in Dashovuz Province of Turkmenistan, bacteria levels in drinking water exceeded the sanitary level by 10 times and about 70% of the population have experienced illnesses, many with hepatitis, and infant mortality is high. The International Fund of Aral Sea (the fund) comprising the five Central Asia countries was established in 1992. An agreement was reached between Turkmenistan and Uzbekistan such that each country uses 50% of the water in the Amu Darya (about 22 million cubic meters per year). Yet, this agreement was based solely on available water resources in the river and did not consider the potential ecological impacts on the Aral Sea or the accumulative capacity of pollutants in the Amu Darya. Interviews with Turkmen officials working at the fund revealed inadequate incentives for regional cooperation due to various political and financial impediments. 4. Sedimentation in reservoirs and irrigation canals in Turkmenistan is a persistent problem that cannot be solved without regional cooperation. Soil erosion in upstream countries contributes considerably to the high concentration of silt in the Amu Darya River. The average capacity of the reservoirs and the KMC are estimated to have been reduced by more than 50% because of sedimentation. This is also because of almost complete silting of Kalif lakes, which performed the functions of a sedimentation tank. In addition, sediment loads also damage irrigation infrastructures and reduce their efficiency. During the Soviet era, the Government had planned to reduce sedimentation in downstream areas by building a reservoir in Tajikistan and controlling soil erosion in upstream areas. At present, the Zeid reservoir is being created to regulate liquid and solid drainage. After its completion, the problem of water turbidity in the KMC

1The total amount of water resources in Turkmenistan is about 25 billion m3, of which 22 billion m3 comes from the

Amu Darya. 2 It is estimated that the body of water had shrunk by about 59,000 square kilometers by 1994.

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may be largely addressed. Turkmenistan has also been tackling this problem through dredging, and is proposing to build a reservoir before channeling the Amu Darya water into the KMC. The number of dredges in operation has declined substantially since independence. Most importantly, dredging and the reservoir itself will not provide a long-term solution to the problem.

5. In addition to these problems requiring international environmental agreements for long-term solutions, Turkmenistan needs to improve its water management system to deal with problems that have more local impacts, such as water losses, soil salinization and erosion, and water pollution. The water losses have been largely caused by the low efficiency of the water distribution system, in particular the poor management of the KMC. Construction of the KMC started in the 1950s and was completed in the 1970s. Many of the KMC sections have not been appropriately maintained, some sections were never cleaned and repaired, causing a huge amount of leakage and seepage losses. This, together with high water intake for flood irrigation and evaporation, has resulted in the loss of 40–50% of the water supply. These water losses have aggravated the problem of natural shortage of water.3 Rehabilitation of the KMC is needed to reduce water losses. Application of more advanced methods (such as concrete covering, lining, and use of polyethylene pipes) could help minimize water losses. However, introduction of these methods will be difficult given their high costs and the great length of the canal. 6. The prevalent method of irrigation (flood irrigation) and the poor drainage system4 in Turkmenistan are the main causes of soil salinization. Flood irrigation generates a huge amount of drainage water,5 which raises the groundwater table, thus intensifying soil salinization. About 55–60% of the irrigated lands is considered to be in an unsatisfactory state because the groundwater lies too close to the surface. So far drip irrigation is not used to a significant extent. It is too costly and may not be an optimal solution without solving the problem of sedimentation simultaneously. Community-based water management through water conservation is an alternative to reduce water losses, as many farmers still believe that the more water is used, the better it is for the plants. The few projects financed by the international financial agencies on community-based water management, training of farmers, and demonstration work deserve to be expanded.

7. Water quality has also increasingly become an environmental concern in terms of both sedimentation and pollution. Pollution of surface and groundwater results from random drainage, application of pesticides and fertilizer, and industrial and household wastewater. While the quantity of industrial and urban wastewater is insignificant relative to agricultural drainage water, industrial wastewater could contain toxic materials and has been discharged into waterways with little or no treatment. Municipal wastewater treatment facilities are inadequate, and in most cases only primary treatment is available. Only 60% of the population is provided with piped water. Lack of access to safe drinking water and sanitation facilities has increased the incidence of water-borne diseases. 8. The problems of water and soil deterioration and the solutions to these problems are closely related. Each of the tasks discussed above—introduction of more efficient irrigation methods, development of an efficient drainage system, rehabilitation of the KMC, minimization of soil erosion and sedimentation, control of water quality—is crucial to improve the ecological situation in the Aral Sea basin in general, and in Turkmenistan in particular. However, each

3 While on average per capita water resource was 1,600 cubic meters in the former Soviet Union, there is only 300

cubic meters per person in Turkmenistan. 4 Only about 40% of irrigated land is provided with drainage systems. 5 The amount of drainage water is 37–54% of the supplied water, compared with the norm of 20 to 25%.

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cannot be a goal by itself. For example, fixing the KMC must be accompanied by establishing efficient drainage systems, or water loss reduction with solving the problems of sedimentation and pollution. More importantly, engineering work alone cannot solve the problems, unless a policy framework encouraging efficient use of water resources is in place and adequate institutional capacity to address natural resource management is established. In addition, rehabilitation of the existing water distribution system would be extremely costly, which requires a long-term strategic partnership between the Government, community organizations, nongovernment organizations, private sector, and external development agencies. 9. Ecological safety is one of the Government’s four development strategies for the next 10 years. While environmental regulation is largely unchanged, with the Soviet model of natural resource management still being followed, the Government has realized the urgency and importance of sustainable utilization of natural resources. It also recognizes that improved management of water resources will be needed if agriculture is to grow on a sustainable basis and that this would include a policy to improve the efficiency of water use. To improve environmental management, the Government has made a series of efforts. Examples include a draft water law that is currently under consideration and would provide the legal basis for introducing water charges; a national environment action plan being prepared with the support of United Nations Development Programme and the World Bank; in addition, the Government has signed and ratified a series of international environmental conventions, including the Arhus Convention on Access to Information; Public Participation in Environmental Matters; United Nations conventions on climate change; combating desertification, and protection of biological diversity. 10. Despite the existing policies and efforts, a significant gap still exists between the Government’s goals and means. Several important constraints to effective management of the environment and natural resources remain: (i) The existing legislation on the administration and management of environment and natural resources has a fragmentary nature, responsibility allocated to too many government agencies. For example, responsibility for water resource management is shared by more than nine national agencies (including the ministries of water economy, water supply and purification, agriculture, environment, and health; Turkmen Geology committee; Institute of Design; and Housing and Communal Services). (ii) Turkmenistan has no comprehensive land use plan. Many of the problems could have been foreseen and avoided, or at least their negative impact minimized with an effective land use plan based on environmental assessment and corresponding management procedures. (iii) The current national policy provides water services without user charges. (iv) Many officials still believe that traditional engineering work (often large-scale and extremely expensive) is the only solution, and do not pay enough attention to small-scale alternatives or community-based natural resource management. The engineering projects proposed by the Government are often impractical given their huge scale and high costs. For example, the Government recently proposed to build the Karakum Lake to improve the drainage system and to turn some of the country’s arid land into arable soil at an estimated cost of $6 billion. (v) Inadequate institutional capacity in terms of both technical and management skills has hindered effective policy analysis and implementation. (vi) Another constraint is inadequate funding for both construction of new facilities and for operation and maintenance of existing ones. 11. Key external development agencies providing assistance in environmental and natural resources management in Turkmenistan include the Global Environment Facility, Organisation for Security and Cooperation in Europe, Technical Assistance to Commonwealth of Independent States, United Nations Development Programme, World Bank, and several bilateral agencies supported by the governments of Britain, Germany, Japan, and the United

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States. United Nations Development Programme has provided a wide range of assistance in environmental management, including initiation of the National Environmental Action Plan, development of sectoral Agenda 21, preparation of the National Biodiversity Action Plan and update of the Red Book on endangered species, training and workshops on community-based water saving programs, and a pilot project on district heating. The World Bank has emphasized improved management of water resources with a lending project on water supply and sanitation ($30 million) in Dashovuz. The World Bank nonlending activities have included assistance in preparation of the National Environmental Action Plan, and workshops and training on Aral Sea rehabilitation in partnership with Global Environment Facility. The World Bank is currently planning to assist the Government conduct a sector study of water resources management. Technical Assistance to Commonwealth of Independent States has been involved in natural resources management especially in the agriculture sector and community-based water management. The Organisation for Security and Cooperation in Europe is involved in implementing the Arhus Convention on Access to Information, Public Participation in Environmental Matters.

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PUBLIC SECTOR MANAGEMENT

1. A number of important governance and institutional reforms have been suggested in the National Program of Socio-Economic Development up to 2010 (2010 strategy). Overall, the focus of the reforms appears to be more on transparency and predictability, while more substantial developments seem required in terms of accountability and participation. 2. Public Sector Management and Social Protection The Government is committed to ensuring minimum living standards for its population. The system relies heavily on subsidization of basic goods such as water, gas, and fuel to the entire population. Although this approach has prevented sharp increases in poverty during the last decade, from a public management perspective, concerns focus on the efficiency, distributional impact, and sustainability of the system. While social security is a key objective of the 2010 strategy, the strategy itself lacks clarity on the fiscal implications, namely how the existing system is to be financed and whether it is sustainable. These are complex issues, that may require external support. Although other external assistance agencies such as the World Bank have been involved in an intensive policy dialogue with the Government on the matter, concrete outcomes are yet to be seen. 3. Public Sector Management and Private Sector Development The transition process to a market economy is still ongoing. The state retains the responsibility for the provision of infrastructure and social services and some commercial activities. To date, public administration and the commercial sector are still not clearly separated. In pharmaceutical production for example, the state has even expanded its commercial involvement. This has led to situations whereby the state is competing with the very small private sector. Privatization of medium and large enterprises has been constrained, in part due to a lack of capital for private enterprises. But overall, the main impediment to private sector development remains the lack of an appropriate regulatory and administrative framework. Most aspects of business operations are subject to either review or approvals by government authorities. Red tape remains a feature of the Turkmen administrative system, and frequent and arbitrary interference by administrative bodies in commercial transactions1 are often reported that undermines long-term investment potential for both domestic and foreign capital. The 2010 strategy acknowledges these problems and envisages action to foster private sector development in the following areas: (i) new legal and regulatory framework for the stock market, (ii) support for small businesses both by reducing bureaucratic obstacles and providing financial and technical assistance to private companies, and (iii) fair competition and privatization of large companies.

4. Separation of Powers While the Constitution provides for the separation of powers between the legislative, executive, and judicial branches, and stresses the importance of checks and balances, the system is weak and the President controls all major decisions at all levels of government. Although the 2010 strategy does not envision any changes in terms of separation of powers at the central level, it has indicated willingness to eventually transfer power from the center to the regional levels. Some promising preparatory analytical work is planned in the coming two years by the Turkmen National Institute of Democracy and Human Rights to improve the regional government system in Turkmenistan.

1 Based on a survey conducted in 1998–1999, companies identified the following major procedures and requirements as the most significant barriers to their operations and growth (in order of importance): (i) registration of import/export contracts with the State Commodity Exchange, (ii) restrictions on access to hard currency; (iii) business licensing, (iv) business registration, (v) inspections and audits by governance bodies, and (vi) customs and product certification.

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5. Institutional Set-up at the Regional Level According to the Constitution, local executive power is exercised by the local executive (hyakim) which oversees the provinces (velayats), the rural districts (etraps), and the urban districts (shakher). The hyakims are appointed by and represent the President. There are regional budgets at the velayat, etrap, and city level. The state budget allocates funding to hyakims, which are assigned substantial expenditure responsibilities in the areas of primary and secondary education, basic health care facilities, and local law enforcement functions. The hyakims do not have the power to levy their own revenues. No clear legal distinction is made between the functions that are performed by the deconcentrated and/or that of the decentralized apparatus. The distribution of functions between the velayats and the urban and rural districts is also not clearly stipulated. So far, the Government has not been able to set up representative institutions (such as regional parliaments for instance) to ensure that the local executives at these levels are accountable to their constituencies.

6. Budget Management The management of public finances in Turkmenistan is characterized by a structure consisting of three parts: (i) the state budget; (ii) state funds of autonomous bodies such as the Oil and Gas Fund, ASian Development Fund, Transport Fund, Health Fund, and Foreign Exchange Reserve Fund; and (iii) off-budget activities undertaken by “self-financing” ministries. The absence of a comprehensive presentation of revenues and expenditures makes forming a complete picture of the Government’s financial transactions difficult. The Government has recognized this problem, and in 1999 started including financial transactions of a number of state funds in the budget. However, the coverage is far from complete. For example, the Foreign Exchange Fund transactions remain unpublished and the Ministry of Economy and Finance (MOEF) is said to control only about a fifth of state expenditures.

7. In recent years, the Government of Turkmenistan has shown commitment to and made progress in improving budget management practices. The 1996 Law on Budget System is an important step forward to provide a framework for budget management. With the help of United States Agency for International Development (USAID), MOEF adopted internationally recognized financial and accounting classification and coding, and upgraded the analytical and computer capabilities of its budget department. Consequently, the number of agency budgets and autonomous funds included in the budget increased substantially. In addition, USAID is currently helping the Government to strengthen coordination across various subdepartments, such as macroeconomic development, fiscal policy, capital investment analysis and budgeting. The United Nations Development Programme (UNDP) and World Bank are also supporting the Government’s Budget Reform Program by focusing on the computerization of the treasury departments at central and local levels. A number of concrete activities aiming at increased budget transparency and accountability are mentioned in the Government’s strategy. Given the importance of improved budget management practices, UNDP and World Bank intend to continue their respective effort. In addition, the World Bank is considering providing assistance to help the Government consolidate revenues and expenditures into one budget. 8. Public Investment Apart from the level of public investments, which is very high, the management of public investment also raises concern because of its fragmented nature. MOEF, the State Agency for Foreign Investment, the Office of the President, and numerous technical ministries and subordinated enterprises all carry out some kind of investment analyses. Coordination between these departments is sometimes lacking. Public investment and recurrent expenditures are not clearly separated. Public investment is often either unrecorded, not clearly documented, or completely off-budget. Since the beginning of 2000, the Government has started listing some public investments outside of MOEF’s control in a separate volume of the

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budget document. The Government openly recognizes its constraint in setting and enforcing its own investment priorities due to a lack of information and has sought support in this area. 9. Budget Revenues As far as the revenue side of the budget is concerned, the budget is extremely vulnerable, as a major portion of the expected revenues is tied to gas exports to Commonwealth of Independent States countries, which are often paid for through barter arrangements and are grossly undervalued. The State Tax Inspectorate, an independent agency outside MOEF, is responsible collecting taxes and reporting receipts to MOEF. The current tax system is heavily dependent on gas and cotton levies. Huge tax payments arrears exist. The system is also characterized by large volumes of “budget offset” transactions defined as payments made in kind by ministries and their enterprises to settle tax liabilities. Considering the time-consuming nature of these transactions, the Government introduced several measures in 1999 to limit the use of such transactions. For example, all transactions involving more than three participants were prohibited, and the range of goods and services for which such offsets could be used was severely restricted. Since February 2000, the Government has introduced a bill system to facilitate greater control over such transactions. A draft tax code prepared by the Tax Inspectorate, primarily aims to expand the tax base, to simplify the tax system, and to make the system more equitable. The draft was to be submitted to Parliament for a second review in March 2001. Although Technical Assistance to Commonwealth of Independent States initially supported the development of the draft tax code, it may be unable to continue its support during the crucial implementation stage, which may result in deficient support. 10. Procurement Public procurement is used for about half of the national budget, and actual procurement is based on a variety of laws and regulations (such as the Law on Investment Activities and Law on Foreign Economic Activities), which are applied on an ad hoc basis. The Government recognizes the benefits of procurement reform and a draft law drawn up with World Bank assistance and submitted it to the Parliament in 2001. For technical reasons the World Bank will be unable to continue its grant past June 2001, so that support for the law if and once it is passed may be inadequate.

11. Legal and Judicial Reforms The legal system in Turkmenistan is still in a process of transition. A consistent and harmonized body of laws and regulations is not yet available. Despite the adoption of the new Constitution in 1992, certain laws and regulations of the former Soviet Union remain in force, sometimes contradicting more recent laws. Implementing regulations for some important laws that have been only recently passed such as the Criminal Code (1998) and the Civil Code (1998) are still missing. The apparent lack of knowledge and/or understanding from some government officials on the content of new laws is an additional constraint to their application. 12. Some progress has been made in terms of transparency. Under Turkmenistan law, normative and legislative acts of the Parliament as well as Presidential decrees are required to be published in newspapers prior to entry into force. In addition, regulations, instructions, or other acts of general applicability issued by individual ministries are required to be registered with the Ministry of Justice and must be published in the Bulletin of Normative Acts of Ministries and Bodies. This latter requirement has not been followed so far. The system of judicial protection of rights is also not effective yet. The implementation of the “Law on appealing to court the actions of state bodies, public associations, of local self-government and official functionaries violating constitutional rights and freedoms,” which was adopted in 1998, can be instrumental in this regard. According to the 2010 strategy, the Government intends major legal and judicial reforms. Among them are the passing of the criminal and procedural code, the law on courts, the law on the office of the public prosecutor, as well as the law on legal profession

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and the legal status of lawyers. USAID intends to help the Government strengthen the professionalism and ethical practices of lawyers, and provide increased access for citizens and officials to Turkmen and international legislation. The World Bank aims to increase information quality and dissemination. 13. Civil Society Participation Although according to the Constitution “each citizen shall have the right to participate in managing the affairs of the state, both directly and through his or her freely elected representatives,” actual participation from civil society in the central decision-making process is very limited. The President has frequently declared that Turkmenistan will follow its own way to democracy and that Turkmenistan is not ready to embrace democracy before 2010.2 Not much progress has been made in terms of participation. Public investments often do not match local needs. A major bottleneck seems to be the difficulty for nongovernment organizations to be registered by the Government. The current legal situation prevents NGOs from engaging in a number of activities and from raising funds, which makes them entirely dependent on the good will of the Government. Since the Government appears to be somewhat reluctant to continue civil society development, external assistance in that area is minimal. USAID maintains a modest democracy program in Turkmenistan to encourage citizen participation, foster democratic concepts, and facilitate access to information and community development/self-help activities.

2 The National Institute of Democracy and Human Rights, which was established in 1996 and is entitled to develop

the legislative base for human rights and democracy, emphasizes primary human rights to be followed by civil and political rights at a later stage.