The public sectors of the Central Asian states still exhibit many of the characteristics of the former Soviet Union. Although the measured size of the public sector, relative to GDP, has been reduced in all countries, governments continue to exert a strong influence on most aspects of economic activity through traditional budgetary operations (central and local budgets as well as various extrabudgetary funds); quasi-fiscal operations performed by the state-owned financial and nonfinancial enterprises; extensive regulation of several aspects of economic and social activity; and informal links enabling government administrators to influence and guide decisions by state enterprise managers and many seemingly privatized enterprises.1 The relative size of the general government sector in these economies was curtailed by the persistent decline in the revenue base (see Section VIII), limited capacities of these countries to access foreign funding, and the need to contain fiscal deficits to levels compatible with restrained financial policies, rather than by discrete measures to contain government operations.

The public sectors of the Central Asian states still exhibit many of the characteristics of the former Soviet Union. Although the measured size of the public sector, relative to GDP, has been reduced in all countries, governments continue to exert a strong influence on most aspects of economic activity through traditional budgetary operations (central and local budgets as well as various extrabudgetary funds); quasi-fiscal operations performed by the state-owned financial and nonfinancial enterprises; extensive regulation of several aspects of economic and social activity; and informal links enabling government administrators to influence and guide decisions by state enterprise managers and many seemingly privatized enterprises.1 The relative size of the general government sector in these economies was curtailed by the persistent decline in the revenue base (see Section VIII), limited capacities of these countries to access foreign funding, and the need to contain fiscal deficits to levels compatible with restrained financial policies, rather than by discrete measures to contain government operations.

Role of the Public Sector

At the outset of the adjustment process, insufficient attention was paid to cutting back public sector responsibilities in the Central Asian states. As a result, most of the countries reviewed continue to retain formal responsibility for large public sectors (including quasi-fiscal operations outside of the budget, as noted before), not much smaller than what existed under the Soviet Union. In addition to the traditional functions of defense, foreign affairs, and law enforcement, most states maintain extensive public education and health systems and elaborate—although often poorly targeted—social security arrangements. Governments also continue to bear responsibility for the bulk of the deteriorating infrastructures from the socialist period, including transport facilities, public utilities, and state property. Substantial involvement also continues in a number of areas less central to traditional public sector functions, including recreation and cultural activities, housing, scientific research, and regulation of economic services such as power supplies and transportation. Finally, there is extravagant state spending in some of the Central Asian states (notably Turkmenistan) on public buildings, monuments, and sports and cultural facilities.

Faced with financial constraints, however, governments have had to contain expenditure. For much of the period surveyed, expenditure restraint has largely relied on across-the-board measures, with the emphasis on compression via sequestration, wage and staff freezes, postponement of capital projects, and neglect of essential maintenance on existing facilities. There has been growing recognition in these countries that such an approach, if sustained, would substantially erode the overall quality of key services and infrastructure. Efforts have been stepped up to modify the role of the public sector. Actual recognition of the likely permanence of revenue constraints has encouraged the adoption of measures to cut spending and to promote private sector provision of selected services, particularly in health and education. In Kazakhstan, the local government sector is in the process of privatizing the operations of a number of health care, education, scientific, cultural, and sports facilities. The licensing of private education institutions has increased almost sixfold since 1995, though it started from a low base. Substantial progress has recently been made in streamlining social safety nets in the Central Asian states, with some countries taking steps to completely eliminate or substantially replace untargeted and costly budget subsidies with more cost-effective cash benefit payments. Several countries now have some privatized health sector activities such as pharmacies. Pension reform is also high on the agenda for most of these countries, notably Kazakhstan (see Section VIII).

Meanwhile, decreasing the public service role of state-owned enterprises has necessitated additional spending by local governments. In Kazakhstan and the Kyrgyz Republic, state enterprises have begun to divest social assets, such as preschools and health care facilities, to local governments, which have attempted to fund these activities with taxes and other revenues. Because the standards of services provided by local governments (with their limited resources) do not always match the standards of profitable enterprises, there remains some pressure for the state enterprise sector to retain these services. For example, in some towns in Turkmenistan, the state gas company retains responsibility for schools and other facilities, which local governments would have difficulty financing. The broader task of privatizing state enterprises (discussed in Section VIII), particularly the larger enterprises and those engaged in utilities, is also proving to be a slow and difficult task within the region, although Kazakhstan and the Kyrgyz Republic have made encouraging starts. Privatization of medium and large public enterprises has been a slower process in Uzbekistan, and it has barely begun in Tajikistan and Turkmenistan. The reasons are primarily because of ongoing civil strife and legal impediments in Tajikistan, and strong resistance by the line ministries and an overvaluation of the few enterprises that were put up for sale in Turkmenistan. In almost all of these countries, state enterprises are being commercialized as a first step toward their eventual sale.

Most Central Asian states continue to use their still largely government-controlled banking sectors to perform quasi-fiscal activities; deficits are often incurred by such operations. In Kazakhstan, for example, public debt guarantees and use of the banking system to clear public sector arrears were major factors contributing to the quasi-fiscal deficit in the period before 1995. In Turkmenistan, the cost of highly subsidized, directed credits—the government authorized lending through the central bank to sectors designated as being of national importance 2–is essentially met by the seigniorage and other profits of the central bank that, in turn, reduces revenues from profit transfers to the budget. The cost of such activities is not presently shown as part of general government operations. There are also no provisions for government-guaranteed loans (some to finance the cotton sector, others to meet construction costs of government projects) in the budget,3 although these loans partly finance quasi-fiscal activities and are often called in. Crop financing arrangements, similar to those in Turkmenistan, also exist in Uzbekistan, and on occasion, large on-lending allocations in the budget must be made to the agricultural sector to cover the servicing of outstanding farm debt. As in Turkmenistan, guarantees on foreign loans contracted for cotton financing and capital projects are not captured as quasi-fiscal activity of the public sector.

In addition to the more explicit role of government outlined above, government regulations impinge heavily on most of these economies, through setting state orders for key crops; contracting production and pricing arrangements for farmers with the state (notably in Turkmenistan and Uzbekistan); placing price controls on some products and services; controlling the sale and purchase of housing and industrial land; licensing and placing other requirements on the establishment of businesses and foreign investment; regulating wages and recruitment practices; putting restrictions on access to foreign exchange; requiring foreign trade registration with the commodities exchange; and imposing surrender requirements on export earnings.

Fiscal Adjustment Policies

Strategies to Reduce Fiscal Imbalances

Following independence, the Central Asian states experienced the loss of grants and other revenue from Russia. This development, in conjunction with the sharp output declines at the outset of transition, quickly triggered unsustainable fiscal deficits.4 The need for fiscal adjustment to complement monetary stabilization became particularly apparent when the Central Asian states introduced their national currencies after the collapse of the ruble zone in 1993. Subsequent efforts to reduce fiscal deficits and contain inflationary pressures followed a bumpy road. Fiscal adjustment was, in most instances, repeatedly undermined by deteriorating revenue performance associated with the transition. The decline in revenue (ranging from 7 percentage points of GDP in Kazakhstan to 30 percentage points of GDP in Turkmenistan during 1992–95) reflected, for the most part, falling output, poor performance of state enterprises, and difficulties in adjusting tax policies and administration to the needs of a growing private sector. While strenuous efforts were made to suppress expenditure, attempts to protect certain spending categories and unforeseen events frequently resulted in a buildup of payments arrears. In periods of scarce budgetary funds, governments contributed to arrears by not paying for purchases of goods and services and writing off such nonpayments against tax arrears by the creditor entities (as happened on a large scale in Turkmenistan in 1997 and 1998). These actions postponed the problem and considerably weakened the transparency of government operations. The Central Asian states, therefore, experienced a start-stop fiscal adjustment—particularly at the outset of transition—with periods of progress interspersed with periods of reversal, and often marked by bank-financed clearances of accumulated payments arrears. The countries also could not adequately protect expenditure in social areas such as health and education, resulting in adverse consequences for human resource development.

Notwithstanding the uneven approaches adopted, most of the countries in the region have achieved underlying structural improvements in their fiscal accounts since independence. The two most successful cases of fiscal consolidation—Kazakhstan and the Kyrgyz Republic—have been aided by ongoing IMF and World Bank-supported program requirements, which have included major structural reforms, notably in the fiscal area. Successful implementation of reform programs have, in turn, assisted these countries in obtaining foreign financing. Uzbekistan’s experience was marked by swings in fiscal policy. Some initial progress was made in fiscal adjustment—again within a program context—before fiscal policy was eased considerably in 1996. The budget deficit was contained at about 2 percent of GDP during 1997–98, although this was primarily achieved by shifting the burden of directed low-interest credits back to commercial banks. The task of fiscal adjustment in Tajikistan was complicated by civil strife and natural disasters, although an ongoing IMF-supported arrangement has started to yield results in 1997 and 1998. In Turkmenistan, the urgency for fiscal adjustment was masked, until recently, by the very narrow coverage of the general government budget, which was balanced during 1996–97. In 1998, however, the fiscal situation deteriorated following the discontinuation of gas exports in the preceding year and the granting of large budgetary wage increases. The country has also tended to resist official involvement of multilateral agencies in program design, instead opting for its own approach to stabilization and structural reform.

Table 4.1 summarizes the fiscal cash deficits in the general government sectors of the Central Asian states and the financing of these deficits from foreign and domestic banking sources. Although the data suffer from weaknesses and may not be strictly comparable across countries, it appears that all countries in the region (with the exception of Uzbekistan in 1996 and Turkmenistan in 1998) were successful in reducing reliance on domestic bank financing of their fiscal deficits during 1996–98. Notwithstanding some common trends, the fiscal adjustment experiences of the individual countries in question varied considerably.

Table 4.1

Fiscal Indicators

(In percent of GDP)

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Sources: National authorities; and IMF staff estimates.

Including grants.

State budget: excludes privatization receipts.

State budget only.

Government expenditure minus revenue. The difference between the fiscal balance and the financing identified in this table is covered by privatization receipts (Kazakhstan) and nonbank financing.

The Kyrgyz Republic budget expenditures and deficits shown here include the externally financed Public Investment Program, which amounted to 4 percent of GDP in 1994 and 1995, 3 percent of GDP in 1996 and 1997, and 5 percent of GDP in 1998.

Kazakhstan’s fiscal adjustment effort began in earnest in 1995. underpinned by a number of structural reforms, including the introduction of a modern tax code. The budget deficit—which had peaked at 7½ percent of GDP in the preceding year because of poor revenue performance and a mismanaged initiative to clear interenterprise arrears—was reduced to 3 percent of GDP. The deficit increased again in 1996, partly due to the adverse revenue impact of reforms in external trade taxation. In 1997 the deficit reached almost 7 percent of GDP, partly the result of a public investment program developed with international assistance, but it also reflected the clearance of pension arrears and reductions in other expenditure arrears. Important structural reforms in taxation and the social safety net were introduced during the year, including the adoption of legislation on a new pension scheme (see Section VIII), A Eurobond issue helped contain domestic bank financing of the budget. The deficit continued to be high in 1998, partly because of the costs of the pension reform that took effect on January 1, 1998. The credibility of Kazakhstan’s reform program allowed it to obtain foreign credits from 1995 through 1998. This became more difficult in the wake of the financial crisis in Russia in 1998, after which a planned Eurobond issue was postponed.

The fiscal stabilization experience of the Kyrgyz Republic bore a number of similarities to that of Kazakhstan. The initial push to reduce the fiscal deficit began after the introduction of the national currency in May 1993. With revenue falling relative to GDP. fiscal restraint in the 1994 budget owed much to expenditure compression, including the elimination of a bread subsidy and other subsidies, but also to a buildup of payments arrears exceeding 4 percent of GDP. While the fiscal deficit, on a cash basis, declined from 14 percent of GDP in 1993 to 12 percent in 1994. there was a sharp reversal in 1995. largely because of a considerable weakening in revenue performance. A sizable reduction in the cash deficit was targeted for 1996, with revenue collections expected to benefit from the adoption of a new tax code and expenditure to be contained by means of scaling back health and education outlays, a tightening in the eligibility for social transfers, and suspension of a scheduled wage increase. Once again, a disappointing revenue performance upset budgetary strategy and the deficit reached 10 percent of GDP. The fiscal situation improved only marginally during 1997–98. as expenditure was boosted by foreign-financed investment projects. Like Kazakhstan, the credibility of its reform program allowed the Kyrgyz Republic to borrow abroad,5 which helped to limit domestic bank financing of the budget. Excluding foreign-financed investment projects, the primary budget recorded a deficit of less than 2 percent of GDP in 1998, down from over 13 percent of GDP in 1995, reflecting a sharp, across-the-board reduction in expenditures.

Fiscal adjustment in Uzbekistan was also uneven, notwithstanding a relatively strong revenue performance, attributable mainly to a smaller output decline. The less precarious revenue situation reflected less strict budget constraints imposed on the still predominantly state-owned enterprises, as well as lack of reform in other areas (i.e., the maintenance of restrictions on cash withdrawals from banks). The general government recorded a deficit of 10 percent of GDP in 1993 due to very sharp expenditure growth, while revenue performance remained strong. Within the framework of an adjustment program supported by the IMF, the deficit was reduced to about 4 percent of GDP by 1995, largely through expenditure compression. Progress was set back in 1996 (with the deficit rebounding to 7 percent of GDP) in the wake of policy reversals and large net lending from the budget as part of an operation to clear payments arrears. The adoption of a number of new tax measures and maintenance of relatively tight expenditure controls through sequestration and sizable cuts in net lending—as subsidized lending was moved back to commercial banks—held the cash deficit to about 2 percent of GDP in 1997 and 1998. In the absence of foreign financing over the past three years, the budget deficit has been financed mainly through domestic bank credit and the purchase of treasury bills by state-owned enterprises.

Although Turkmenistan’s fiscal reform effort since independence has been limited (for example, its tax structure has not changed substantially from that of the original Soviet system), it has seemingly avoided fiscal deficits. Interpretation of the fiscal position, which was nearly balanced during 1993–97, is complicated by the partial coverage of the general government budget and the existence of sizable quasi-fiscal deficits financed through public financial institutions by means of government-mandated directed credits. Less than 50 percent of current public sector transactions seem to pass through the formal budget. As most extrabudgetary spending is financed by external borrowing, the actual public sector deficit (which would include the quasi-fiscal operations of nonfinancial public enterprises) is, in all probability, considerably larger than what is captured in the official budget or reflected in domestic credit data.6 With the suspension of gas sales to traditional markets in 1997 (resumed in early 1999), large consecutive wage increases granted to budgetary organizations, and heavy public spending on construction, the budget deficit deteriorated in 1998 to about 3 percent of GDP, intensifying the pressure on banking system resources. The authorities increasingly recognize the need to develop a coherent plan of action—encompassing all aspects of tax and expenditure policy, as well as institutional capacity building in the area of financial and tax administration—to deal with the deteriorating fiscal situation. The government is also now attempting to monitor a broader public sector (as opposed to the narrow budget) by nominally including the state funds, some price subsidies, and foreign debt repayments on budget, although these operations do not go through the treasury accounts.

Tajikistan’s fiscal adjustment effort showed variations over the period reviewed, as in the other four states of the region. In the earlier years, fiscal policy was characterized by weak tax administration and poor expenditure controls. Notwithstanding a decline in revenue arising from policy changes, which reduced revenue from the key agricultural subsectors (including cotton), the fiscal deficit was sharply reduced in 1996. This was attributable to a massive contraction in the expenditure to GDP ratio, attributable partly to the replacement of the generalized bread subsidy with targeted assistance. As in the other Central Asian states, curtailment of spending brought with it a sharp rise in payment arrears. The problems were compounded by the absence of a centralized treasury capable of documenting and controlling commitments. The post-conflict program initiated in 1997 with IMF support, and followed by an Enhanced Structural Adjustment Facility in 1998, was marked by strong fiscal adjustment, reflecting both revenue measures and improved tax compliance, which enabled progress in eliminating payments arrears. The strengthening of revenue has become more essential, given the need for government expenditure to grow, as a share of GDP, to support improvements in the provision of basic services, rebuild damaged infrastructure, and enhance the social safety net.

The Arrears Problem

All of the Central Asian states experienced significant tax arrears during the transition period and, partly linked to this, incurred large government payments arrears. Government payments arrears became a natural offset to tax arrears. Although these developments mostly mirrored weak state enterprise profitability, there was also a lack of financial discipline among enterprise managers and a failure by the government, as the sole shareholder, to impose hard budget constraints on enterprises. The elimination of tax arrears required enterprise managers to play a more active role in ensuring timely payments, and tax administrations to employ firmer approaches in identifying and collecting overdue taxes. Resolution of the expenditure arrears problem called for the preparation of more realistic initial budget estimates. Beyond this, however, the development of treasury operations, capable of monitoring cash payments against commitments and taking quick action to prevent new arrears from arising, was a crucial element in addressing the problem. Finally, it was essential for governments and central banks to refrain from financially bailing out enterprises persistently in arrears, as such action perpetuated the problem by creating expectations of future bailouts.

The most concerted attempt to reduce expenditure arrears in the region, occurred in Kazakhstan where the central government repaid almost its entire stock of wage and utility arrears at the end of 1996. Arrears at the local government level, together with pension and other payments arrears, however, would have reached about 5 percent of GDP by end-1997 in the absence of measures to clear them. As noted earlier, the authorities repaid pension arrears corresponding to about 2 percent of GDP, in preparation for the introduction of a pension reform, and reduced other expenditure arrears by about 1 percent of GDP during 1997, The authorities intended to clear the remaining arrears during the subsequent two years, but only a limited further reduction could be achieved in 1998 due to the tight fiscal situation. The Kyrgyz Republic also employed an active approach to eliminate arrears, aided by the creation of a strong central treasury and substantive improvements in tax administration. Nevertheless, weaknesses in expenditure management resurfaced during 1998, especially after the onset of the crisis in Russia, Tajikistan, Turkmenistan, and Uzbekistan continue to have substantial tax and expenditure arrears. Turkmenistan has an operational treasury, although the data processing systems in place do not provide timely information on commitments, making it difficult for the authorities to measure and to phase out payments arrears. Treasuries are only now being created in Uzbekistan and Tajikistan, which will help build a capacity to monitor payments arrears. Tajikistan has already made considerable progress by clearing budgetary wage and pension arrears by end-1998. In all five countries, addressing the government expenditure arrears problem will require progress in reducing tax arrears, as these two categories largely serve to offset one another.

Areas for Further Improvement

Fiscal adjustment measures implemented thus far in the Central Asian states constitute the initial steps of a reform agenda that still has a considerable way to go toward completion. With regard to revenue, policies will need to be directed toward broadening the tax base, unifying tax rates, and reducing tax exemptions. Key products, such as oil and gas, will need to be subjected to the full tax regime, while mechanisms are put in place to ensure that the rent associated with exploitation of natural resources is adequately taxed (principally through royalties). The tax status of small businesses and individuals will need to be reconsidered, so that reasonable contributions are obtained, while prohibitive and discouraging marginal tax rates are avoided. Such rates not only encourage a shift of activities to the informal economy, but also reduce the supply of labor and capital of those whose activity is taxed. A revenue mix that imposes unduly high social service and payroll taxes on enterprises (thus discouraging employment), while allowing individuals relatively small contributions, will need to be avoided. Tax administration is underdeveloped in most Central Asian states, and there is a need to strengthen procedures to assess, collect, and record tax payments. More effective enforcement methods, plus internal control and accountability systems, are also needed.

With regard to expenditure, it will be important to more clearly delineate the respective roles of the public and private sectors in the Central Asian states, including defining the role of enterprises that remain under state control. There is a need to adjust the expenditure mix, with some reduction in the still excessive spending on subsidies, and greater attention paid to spending on health and education. At the same time, spending needs to be made more cost effective through improved design. For example, in the areas of health and education, inefficiencies stemming from overstaffing and excess physical capacity have to be addressed. Also, social safety nets would benefit from closer targeting to vulnerable groups. To implement these reforms, the institutional capacity of the ministries of finance need to be strengthened. While creation of treasuries capable of strong sequestration controls have proved useful in the initial phase of transition, these steps should be bolstered by better identification of essential spending programs and measures to enhance cost effectiveness.


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One example of informal influence is the frequent granting of preferential treatment (e.g., tax concessions) to enterprises in which the government continues to hold a direct interest, often in the form of a joint venture, which permits these enterprises to operate under less strict commercial structures.


These credits, which mainly finance grain producers, are mostly interest-free and often not fully repaid by the recipients.


As of 1999, the budget nominally includes external debt service obligations on government-guaranteed loans, which are serviced by the various state funds.


The exception was Turkmenistan, which was initially shielded from much of the pain of adjustment by revenue from gas sales, before it lost access to European markets for gas exports as of 1993.


In the case of Kyrgyz Republic, borrowing abroad was from official bilateral and multilateral sources on concessional terms.


For example, for the first time, the 1999 budget shows the costs (estimated at about 2 percent of GDP) associated with the free provision of gas, electricity, and water to domestic users.