INTERNATIONAL MONETARY FUND, WORLD BANK, EUROPEAN BANK for RECONSTRUCTION and DEVELOPMENT, and ASIAN DEVELOPMENT BANK

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1 INTERNATIONAL MONETARY FUND, WORLD BANK, EUROPEAN BANK for RECONSTRUCTION and DEVELOPMENT, and ASIAN DEVELOPMENT BANK Report on Progress Under the CIS-7 Initiative Prepared jointly by the European II Department of the IMF, the Europe and Central Asia Region of the World Bank, the Banking Department and Office of the Chief Economist of the EBRD, and the East and Central Asia Regional Department of the Asian Development Bank Approved by John Odling-Smee, Johannes Linn, Willem Buiter, and Joseph B. Eichenberger April 7, 2003 I. INTRODUCTION 1. The CIS-7 Initiative was launched at the Spring meetings of the IMF and World Bank in April 2002, following a seminar in London in February The principal aim of the Initiative is to draw attention to the plight of the seven low income CIS countries Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan. These countries face a particularly difficult transition period and, while significant progress has been made, a long unfinished reform agenda remains. Living standards fell sharply in many of these countries in the 1990s and, with the exceptions of Azerbaijan and Uzbekistan, they also face pressing debt sustainability issues that carry the potential to threaten macroeconomic stability and poverty reduction efforts. 2. The Ministerial Statement that launched the Initiative proposed a renewed partnership between the CIS-7 countries and the international community. 1 The CIS-7 countries committed to strengthen their reform programs, while the international community pledged increased assistance to countries meeting these commitments. Action was envisaged on a number of fronts: (i) addressing the issue of debt sustainability; (ii) improving coordination among bilateral and multilateral donors; (iii) providing knowledge services to the CIS-7; (iv) reinforcing capacity building efforts in the region; and (v) fostering regional cooperation among CIS-7 countries. 3. This report summarizes progress achieved under the Initiative. During its first year, the IFIs have continued to help the countries to strengthen the design and implementation of their reforms, thereby enhancing their growth potential and unlocking the 1 All documents relating to the Initiative, as well as links to key country documents and national websites, are available at

2 - 2 - increased financial assistance pledged by the international community. Given its broad objectives, actions under the Initiative are invariably closely intertwined with regular assistance activities by the international community. II. PROGRESS UNDER THE INITIATIVE 4. Overall, the CIS-7 economies have experienced strong growth, significantly above the rates seen in other parts of the world. In many of the CIS-7 countries, growth has been driven, in part, by the strong performance of the large economies in the region Russia, Kazakhstan, and the Ukraine since the Russian crisis. Growth in the CIS-7 in 2002 continued at the rapid pace seen in The main exception in 2002 was the Kyrgyz Republic, where a sharp slowdown in economic activity was linked to the disruptive effects of a landslide around a large gold mine which accounts for a substantial share of exports. The robust growth in the region is expected to continue in 2003, though the outlook is complicated by the heightened global uncertainties. Uzbekistan Table 1. Real GDP Growth in CIS-7, Armenia Azerbaijan Georgia Kyrgyz Republic Moldova Tajikistan Uzbekistan CIS-7 average Memorandum items: Advanced Economies Developing Countries Countries in Transition Source: IMF. Staff estimates and World Economic Outlook. has lagged behind the rest of the region for the last few years and activity is projected to slow further in 2003, reflecting the continued lack of reforms and an intensification of government intervention in the economy in recent months. 5. Structural reforms have been designed and implemented in the context of nationally developed PRSPs, ensuring strengthened ownership of the reform agenda. Tajikistan (in June 2002), the Kyrgyz Republic (December 2002), and Azerbaijan (February 2003) have already finalized and published their PRSPs. Armenia and Georgia are expected to finalize their PRSPs this summer. Moldova is at a less advanced stage and Uzbekistan is at an early stage in the process. The IFIs have assisted countries in designing their PRSPs, including through the organization of an annual regional forum for national PRSP teams (Box 1).

3 - 3 - Box 1. The Third PRSP Forum in Almaty, December 11 13, 2002 Organized by the World Bank, IMF and UNDP, this Forum for the CIS-7 countries brought together over 200 representatives of national PRSP teams comprising both government officials and civil society representatives bilateral donors and international and regional organizations. The Forum focused on three aspects of the PRSP process: Strategies for equitable growth. This topic included the investment climate, trade as an engine of growth and poverty reduction, rural development strategies, and policies to support social inclusion; Improvements in the design, implementation and monitoring of PRSPs. Key aspects included the use of PSIA, systems for poverty monitoring, linking PRSPs to the budget, and donor alignment in support of PRSP implementation; and Institutionalization of the PRSP to strengthen governance and accountability. Discussions focused on the roles and responsibilities of various groups within civil society community groups, parliament, local government, and the media. A key message from the Forum is the need to ensure that the PRSP become fully integrated into the regular business of government, including budget preparation. This needs to be supported by continued capacity building to enable better analysis of the social impact of policies, as well as higher quality data to support policy design and effective monitoring. A particular concern for several countries is to ensure that disadvantaged groups children, disabled, women, internally displaced persons, and migrant workers benefit from growth. 6. IFI support for country reform strategies has focused on a number of areas: Ensuring macroeconomic stability through the pursuit of an appropriate macroeconomic policy mix. Six of the seven countries have pursued macroeconomic stabilization in the context of PRGF programs with the IMF, though implementation has not been uniformly consistent. The PRGF-supported program with the Kyrgyz Republic has remained on track since its approval in December The PRGFsupported programs in Armenia and Azerbaijan have been brought back on track and a new PRGF arrangement was approved for Tajikistan in December The programs in Georgia and Moldova have experienced interruptions: in Georgia, there have been fiscal pressures stemming from populist measures and tax evasion, as well as delays in energy sector reform; and in Moldova, delays have resulted from uncertainties surrounding the financing of the program, slow privatization, and increasing government interference throughout the economy. Uzbekistan does not currently have an IMF-supported program in place.

4 - 4 - Public expenditure management reform is a key focus of the World Bank s programs in the CIS-7. Public expenditure reviews have recently been completed in Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, and Moldova, and are under preparation in Tajikistan and Uzbekistan. World Bank lending operations (for example, the current structural adjustment credits to Armenia and Azerbaijan) also highlight public expenditure policy and institutional issues. The thrust of these programs is to help ensure that public resource use reflects scarcity and PRSP priorities, given external debt and domestic revenue constraints. Prioritization in expenditures is key, but institutional capacity weaknesses inhibit policy design and implementation. Resource-rich countries like Azerbaijan face the added challenge of spreading the expenditure of their natural resource wealth across time. With the establishment of the necessary legal and administrative framework for its oil fund, Azerbaijan has made good progress to prepare itself for the sharp increase in oil revenues from 2005 onwards. Finally, public expenditure reforms are needed to improve governance and reduce corruption, as highlighted in the Governance Structural Adjustment Credit under preparation for the Kyrgyz Republic. Given the systemic deficiencies in capacity, technical assistance is critical to timely progress. The IMF has also devoted considerable technical assistance resources to strengthen national treasuries a key element in public expenditure management systems. In particular, resident treasury advisors were assigned to Armenia and Azerbaijan during 2002 and advisors are expected to take up posts in Georgia, the Kyrgyz Republic, and Uzbekistan during A number of bilateral donors are also very active in this area. Policy and expenditure reforms in education, health, and social protection are essential components of a viable PRSP. In addition to keeping track of distributional aspects of growth, specific policies designed to integrate the poor and disadvantaged into the growth process are essential. Poor delivery of education and health services combined with reduced and ineffective social protection systems have contributed to the declining social indicators seen in most countries. The national PRSPs highlight these issues, identifying the need to improve the efficiency of expenditures in these areas through better public sector management including bringing benefits and budgets in line, downsizing, restructuring curricula and educational methods, and improvements in the efficiency of public programs. In addition to its support for strengthening public expenditure management, the World Bank and ADB are supporting this process through technical assistance, analytic and advisory services, and lending. Recent initiatives include: (i) technical and analytical input on education policy challenges and possible solutions in Central Asia; (ii) support for a major health reform initiative in the Kyrgyz Republic; and (iii) developing a social protection reform agenda in Armenia, Azerbaijan, and Georgia. Tax policy and administration, including customs, reforms have focused on removing distortions, broadening the tax base, and providing a more transparent tax system. In addition to strengthening revenue collections, such reforms have contributed significantly to the improvement in the investment climate. The IMF has

5 - 5 - provided technical assistance to each of the CIS-7 in these areas and the World Bank has also implemented a number of projects, particularly in customs administration. While tax policy continues to improve, difficult issues surrounding the taxation of agriculture, small businesses, VAT refunds and social contributions remain. Further efforts to enhance tax administration capacity will also be needed to ensure lasting improvements in compliance. Energy sector reform has been and continues to be a priority throughout the CIS-7. The widespread use of below-cost pricing of energy as a social policy to support poor citizens and as an industrial policy to help energy-intensive production is a legacy of the Soviet Union. Combined with non-payment and excessive energy losses, often as a result of theft, this policy in effect provides substantial explicit and implicit subsidies. In some of the CIS-7 countries, these subsidies and losses led to large external energy-related debts, and in many to a deteriorating energy infrastructure as witnessed by frequent power shortages and blackouts. To address these socially and politically sensitive issues, the IFIs have supported an approach based on three principal components: (i) improvement of bill collection and reduction of energy and power system losses; (ii) staged tariff increases to improve the financial viability of the energy companies, accompanied by mitigation measures, including improved targeting of social protection benefits, to compensate the poor at least partially for these tariff increases; and (iii) further measures to improve financial viability, operational efficiency, and upgrade deteriorating energy infrastructure, including privatization or private management contracts. While the energy reform agenda in the CIS-7 countries remains considerable, some progress is being made with the support of the World Bank, for example in Armenia and Azerbaijan. The ADB is involved in power sector projects in the Kyrgyz Republic, Tajikistan, and Uzbekistan, and aims to strengthen regional cooperation in power transmission. The EBRD has also been active in the energy sector with policy dialogue and on-going investment projects in Georgia, the Kyrgyz Republic, Moldova, and Uzbekistan. The IFC has supported the restructuring and privatization of the sector in the region through energy-related investments in Georgia, Moldova, and Tajikistan and through privatization advisory services to the Armenian and Georgian governments. Extent of the Bribe Tax 4.5 The investment climate for SMEs has 4.0 improved somewhat in the last few years. According to the most recent 3.0 EBRD-World Bank Business 2.5 Environment and Enterprise 2.0 Performance Survey (BEEPS), 1.5 enterprise managers perceive that 1.0 some aspects of the investment 0.5 climate, including the incidence of 0.0 corruption, have improved since Armenia Azerbaijan Georgia Kyrgyz Republic Yet, there is ample evidence that much Source: EBRD-WB BEEPS, 2002 Average bribe as percent of firm revenues Moldova Tajikistan Uzbekistan

6 - 6 - remains to be done to secure a sound and competitive business environment. Programs and policy dialogue initiatives are underway in several countries to strengthen corporate governance, to deepen administrative and judicial reforms, and to reduce corruption. For example, the IFC Private Enterprise Partnership (PEP) was set up with the support of many bilateral donors to provide SMEs with technical assistance and to work with their governments on improving the legislative framework for SMEs. The initial focus of the PEP has been Armenia, the Kyrgyz Republic, and Uzbekistan, with an expanding program to Georgia and Tajikistan. The ADB has supported reforms in these areas through policy-based loans and technical assistance in the Kyrgyz Republic. Most of the CIS-7 countries have made considerable progress both in the privatization of businesses and land. Financial sector reform to ensure the emergence of a sound competitive financial system capable of providing effective intermediation has been supported through extensive assistance from each of the IFIs. In several cases, development programs have been drawn up in the context of the comprehensive assessments of financial systems undertaken in the IMF/World Bank Financial Sector Assessment Program (FSAP): the Kyrgyz Republic participated in the FSAP in 2002, while Azerbaijan will participate in 2003 and Moldova has also agreed to do so; Armenia and Georgia participated in earlier years. Technical assistance in support of identified needs for each of the CIS-7 countries has been provided by the IMF and World Bank in a variety of areas, including bank restructuring (the Kyrgyz Republic and Tajikistan), accounting reform (the Kyrgyz Republic), and payments system projects (Armenia, Georgia, the Kyrgyz Republic, and Moldova). The ADB has supported bank restructuring, accounting reforms, and adoption of corporate governance reforms (in the Kyrgyz Republic). The ADB, EBRD, and IFC have also supported private financial institutions through loans and technical assistance to commercial banks on issues such as credit assessment. The EBRD and IFC have also taken or increased equity stakes in banks in Georgia, the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan. Direct support for private sector development has continued. The IFC has a portfolio including both larger projects in areas such as oil, gas, mining, and utilities, and smaller pilot projects. For example, in cooperation with the IFC, an innovative private ownership model with 365 individual owners was developed for a company in Tajikistan to provide farm inputs and marketing services for the cotton farms owned by these individuals. The EBRD and IFC provide financial facilities, including credit lines to small and medium-sized enterprises (SMEs), micro and small enterprises (MSEs), and Trade Facilitation to support private sector development. The EBRD also invests in local SMEs as a minority shareholder through the Direct Investment Facility (DIF). 2 To accelerate support for the private sector, the EBRD established the 2 A facility by which the EBRD takes minor equity stakes in small local enterprises in the private sector.

7 - 7 - CARSSF (Central Asia Risk Sharing Special Fund) in July Similarly, one focus of IFC activities in the CIS-7 countries is the improvement of SME access to financing. The IFC is supporting micro-enterprises by promoting micro-finance institutions in Azerbaijan, Georgia, Kyrgyz Republic, and Moldova. Furthermore, the IFC has contributed to the development of financial leasing in Armenia, Georgia, Uzbekistan, the Kyrgyz Republic, and Tajikistan. The ADB has provided credit line facilities to SMEs in Uzbekistan and designed micro-finance and savings and credit union development programs in the Kyrgyz Republic and Uzbekistan. 7. The benefits of generally liberal trade regimes have been limited by regional trade and transit barriers. With the exception of Uzbekistan, all countries maintain fairly open trade regimes with low tariff rates using the IMF s index of trade restrictiveness, all but Uzbekistan have a rating of 1 or 2 on a 10-point scale; Uzbekistan rates 9. 4 In February 2003, Armenia joined Georgia, Kyrgyz Republic, and Moldova as a member of the WTO. The CIS-7 countries also participate in a number of regional trade initiatives, including the CIS free trade zone and the Eurasian Economic Community (a customs union involving Belarus, Kazakhstan, Kyrgyz Republic, Russia, and Tajikistan). Potential benefits from trade openness have been constrained by the continued incidence and spread of bilateral trade disputes and transit disruptions, as well as weak customs services. In the Caucasus, the borders between Armenia and both Azerbaijan and Turkey remain closed, and there have also been disruptions at the border between Georgia and Russia. Trade issues between Moldova and Ukraine persist because of the unresolved situation in Transnistria. In Central Asia, transit restrictions and ad hoc tariffs are common among neighboring countries, and there have been occasional closings of some of Uzbekistan s borders. These restrictions appear especially costly for the poorest of the CIS-7 the Kyrgyz Republic and Tajikistan. 8. A number of initiatives are underway to facilitate trade. Regional transportation facilitation projects have proceeded in the Caucasus (World Bank) and in Central Asia (ADB) focusing on regional road and rail transportation networks. These projects complement the EU s TRACECA project, designed to build a transportation corridor between the Caucasus and Central Asia. An initial round of trade diagnostic studies by the World Bank is nearing completion and will form the basis for designing future trade reform agendas. Difficulties at customs borders are being addressed by the ADB through Regional Customs Cooperation projects with each of the Central Asian countries. Trade issues have 3 Under the CARSSF, the EBRD shares first-loss risks on its operations with donor grant funds. The operations that are covered by this include the Trade Facilitation Program, SME and MSE credit lines, and DIF. Countries currently covered are Uzbekistan, Tajikistan, and the Kyrgyz Republic, as well as Turkmenistan. 4 The index combines information on the average level of tariff protection, as measured by statutory tariff rates for imports, and the coverage of non tariff barriers in relation to trade and production in the economy.

8 - 8 - also been the focus of regional business fora in Central Asia the next one of which is scheduled to be held in May 2003 in Osh, Kyrgyz Republic that bring together businessmen and government officials. Constraints on the availability of trade finance are being addressed through the EBRD s Trade Facilitation Program, in which the EBRD guarantees letters of credit from local banks. Existing programs in the Kyrgyz Republic and Uzbekistan have led to a significant increase in the volume of trade credit. A program is under preparation in Tajikistan. 9. Advances have also been achieved in other aspects of regional cooperation, specifically water and energy. A major cooperation project in the region, supported by the ADB and World Bank, is the Aral Sea Basin Program that brings together Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan in an effort to save the Aral Sea. Through its Central Asian Regional Economic Cooperation program, the ADB has designed a number of projects to rehabilitate and upgrade the electric power system in the region in some cases with direct investments by the EBRD and projects to complete and renovate gas pipelines in the region are being developed. These projects should facilitate the expansion of energy trade in the region and a more rational use of energy and water resources. 10. Bilateral donors have provided support to those countries implementing reforms, increasingly on a grant basis. The December 2002 Consultative Group meeting for the Kyrgyz Republic the first Consultative Group meeting in the region based upon a PRSP document generated substantial pledges of support, with a large proportion of the pledges being grants. Moldova has also received pledges of increased grant support from the EU, conditional on continued implementation of reforms. Tajikistan is scheduled to have a meeting of its Consultative Group in May 2003 to discuss donor support for its PRSP. 11. Each of the IFIs has contributed to institution building through technical assistance in their core areas of specialization, in several cases funded by bilateral donors. Significant additional resources have been made available by donors to support the provision of technical assistance in the region. At the IMF, dedicated accounts established by the governments of Italy, Japan, the Netherlands, and Switzerland have financed a range of technical assistance activities. In addition, there has been an increased emphasis on regional events for example, a CIS-wide seminar on indirect taxation issues held in Almaty in June 2002 that was funded by the Government of Italy and a seminar on deposit insurance for Central Asia, Azerbaijan, and Mongolia in Basel in January 2003 organized by the EBRD and the IADI (International Association of Deposit Insurers), sponsored by the Swiss Government in cooperation with Japan. The EBRD s legal transition program has continued to provide technical assistance funded by donor grants for the drafting of laws in the areas of secured transactions, bankruptcy, telecommunications, foreign investment, and leasing.

9 Debt indicators have improved in each of the five heavily indebted countries, in some cases beyond the levels envisaged at the London seminar, but further progress is needed to ensure sustainability a key objective of the CIS-7 Initiative from its outset. The improvement in NPVs reflects a combination of strong macroeconomic outcomes and, in some cases, more favorable than anticipated rescheduling agreements with creditors. 5 Debt indicators in Armenia and Georgia are significantly stronger than envisaged in the baseline projections discussed at the London seminar in the case of Armenia, this is due to the very strong macroeconomic outcomes combined with the debt-equity swap agreed with Russia. Despite the progress achieved, debt ratios remain high and will continue to be monitored carefully. Table 2. Debt Sustainability Indicators London Latest Seminar DSA 2003 Armenia Georgia Kyrgyz Republic Moldova Tajikistan HIPC threshold Armenia Georgia Kyrgyz Republic Moldova Tajikistan HIPC threshold Source: IMF estimates. NPV of debt to exports 1/ NPV of debt to central government revenue 13. Debt restructuring strategies continue to be conducted on a case-by-case basis (Box 2). Georgia and the Kyrgyz Republic concluded Paris Club rescheduling agreements that have provided a framework for negotiations with other bilateral creditors. In contrast, Armenia and Tajikistan negotiated directly with key bilateral creditors. For Moldova, the process is still on-going, but a start was made with the restructuring of obligations to private creditors. III. LUCERNE CONFERENCE 1/ NPV of external sovereign debt relative to three year average exports of goods and nonfactor services. 14. A high-level conference on the CIS-7 was held in Lucerne, Switzerland in January The Conference had three principal objectives: (i) to take stock and draw 5 The magnitude of the reductions in NPVs is tempered by the reduction in global interest rates, which has the effect of increasing the NPV of existing debt stocks. 6 The conference was organized and sponsored by the World Bank, the IMF, the EBRD, and the ADB, and was hosted by the Swiss Government. Additional financial support was provided by the Dutch Government. The event was attended by representatives of the CIS-7 countries both senior government officials and members of civil society multilateral organizations, donor and academic communities, and international NGOs. Keynote speakers included Kaspar Villiger (Minister of Finance, Switzerland), Yegor Gaidar (Institute for Economy in Transition, Russia), George Soros (Soros Foundation), and Chingiz Aitmatov (Kyrgyz Ambassador to the EU and NATO). The Conference was opened by Shigemitsu (continued)

10 Box 2. Recent Developments in External Debt Armenia: A debt equity swap with Russia is expected to be finalized in April 2003 in which Armenia s public debt to Russia ($94 million, or 10 percent of the nominal value of the debt stock at end-2002) is to be exchanged for Russian stakes in some of Armenia s state-owned enterprises. The operation is estimated to reduce debt service payments in 2003 by 0.5 percent of GDP. Georgia: In March 2001, Paris Club creditors granted a nonconcessional flow rescheduling of maturities falling due in 2001 and The agreement included a goodwill clause indicating that an additional rescheduling covering 2003 maturities could be considered following the successful implementation of the PRGF program. Liabilities to major non-paris Club bilateral creditors have been restructured on comparable terms. Kyrgyz Republic: In March 2002, Paris Club creditors granted a nonconcessional flow rescheduling of debt falling due in Bilateral agreements have been finalized with the key Paris Club creditors but comparable terms agreements with most non-paris Club bilateral creditors are still under discussion. The Paris Club agreement contains a goodwill clause indicating that if the PRGF-supported program is implemented successfully, a stock of debt operation could be considered. Moldova: In October 2002, the authorities reached agreement with private sector creditors to reschedule the outstanding $39.7 million of the Eurobond issued in The terms of restructuring included a payment of 10 percent of principal in the last quarter of 2002 and 5 percent of principal in , followed by equal payments over the remaining period to Interest will be paid at the rate of six-month LIBOR plus basis points. The agreement provided substantial short-term cash relief and together with previous buyback operations led to an 8½ percent reduction in the total NPV. The authorities are seeking debt rescheduling agreements with Paris Club creditors and with Russia s Gazprom. Tajikistan: Agreements have been signed with key bilateral creditors: in December 2002, Russia agreed to reschedule $323 million of debt (a third of the end-2001 debt stock) at an interest rate of 4 percent with a maturity of 17 years and a three-year grace period; in February 2002, Uzbekistan agreed to reduce the stock of debt by 10 percent, lowered the interest rate to 0.8 percent and extended maturities to 10 years (with a two- year grace period); and in April 2002, Kazakhstan agreed to reduce the debt stock by one third, with a 2.8 percent interest rate, a 15-year maturity, and a five-year grace period. lessons from the first decade of transition in the CIS-7 countries including the role played by the international community; (ii) to highlight the most pressing problems of the region; and (iii) to generate fresh ideas from outside the official community on the economic Sugisaki (Deputy Managing Director, IMF), with closing remarks by Shengman Zhang (Managing Director, World Bank). The background papers are available in both English and Russian on the CIS-7 website. A conference volume is forthcoming.

11 challenges facing the CIS-7. The Conference was structured around a series of panel discussions based on background papers prepared by academics and policy makers that generated a lively debate. Key points of note included: The record of transition 15. While criticizing some aspects of the role played by the international community in the early stages of transition, the background papers did not suggest fundamentally different policy approaches for the region. It was noted that the IFIs and the international community in general had underestimated the extent of the disruption caused by the breakup of the Soviet Union and the time needed to build the institutional capacity necessary to effectively implement essential reforms. As a result, the economic contraction during the transition lasted longer and was deeper than expected. 16. At the same time, external debts increased rapidly. In part this was because countries were able to borrow sizable amounts from the IFIs. For energy-importing countries, an additional factor was the failure to aggressively restructure the energy sector, which led to substantial quasi-fiscal deficits, ultimately converted into government liabilities. The discussions concluded that a financing mix more heavily tilted toward grants and concessional lending during the early stages of transition would have been more appropriate to address the basic needs of populations confronted with rapidly declining living standards while helping to avoid the large debt buildup. In the absence of such financing, recourse to borrowing was the only option to limit further declines in living standards. 17. Government representatives acknowledged the value of policy advice, capacity building and financial assistance received from the IFIs. At the same time, there was broad support for the view that, to make reform programs work, policy makers should chart the course of reforms based on their own country experience. This in turn led to calls for additional donor support for capacity building to help countries implement reforms more effectively. The challenges ahead 18. It was widely agreed that the reform agenda remained challenging. Prospects for sustained growth and poverty reduction over the medium term depend critically on governments ability to implement structural reforms. In particular, countries needed to ensure that any acceleration of growth would translate into reduced poverty and improved living standards. Participants reached similar conclusions on the main problems and bottlenecks their countries faced. Notably, there was a clear consensus about the need to tackle corruption, improve governance, and strengthen program ownership. Better donor coordination, especially through the PRSP process, and a more focused reform agenda would also help strengthen reform programs. 19. All countries face difficult trade-offs in public expenditure, given the existing financing constraints. An especially challenging task is to balance the competing needs of

12 raising social expenditure and meeting external debt obligations, while maintaining sustainable fiscal positions. Country participants acknowledged that increased efficiency and management of public expenditure was paramount, but appealed for enhanced financial support from donors to help resolve their policy dilemma. There was a realization that countries also needed to do their part through strengthening revenue collections. Significant progress had been made in improving both tax policy and tax administration, but there was room to enhance collections by broadening the tax base and more effectively administering existing taxes. There were some calls for reductions in the tax burden, but most participants seemed to agree that this could be excessively risky given the typical CIS-7 context and the limited room for additional streamlining of expenditures. 20. Private sector development was identified as a crucial item in the reform agenda, given its impact on growth. While a significant improvement in the business environment has taken place during the last couple of years and corruption has come down, CIS-7 countries still lag behind most other transition economies. Therefore, efforts to reduce government intervention and provide a more conducive environment for private sector activity including for SMEs and micro-enterprises and for the banking sectors should be given high priority in the years ahead, especially in view of the modest foreign investment flows into the region. 21. Regional cooperation in a variety of areas was key. Given that many of the economies are small and land-locked, the creation and preservation of an open trade environment would be vital for enabling them to realize their growth potential. In Central Asia, finding equitable solutions to the complex water and energy usage issues was essential to ensure the efficient use of resources in the region. Country participants recognized that the focus on regional cooperation was appropriate, but they insisted that better access to industrial country markets, in particular the EU, was also needed to facilitate growth. Priorities in the period ahead 22. There was a broad consensus on the priorities for the period ahead, namely to: (i) enhance donor financial assistance for countries following appropriate policies including debt relief where needed and improve donor coordination; (ii) improve governance and strengthen ownership and implementation of reform programs, particularly through the PRSP process; (iii) foster capacity building to improve the design and implementation of reforms; and (iv) increase regional cooperation, especially on trade, transport, and energy. 23. CIS-7 participants generally found the conference very useful, both in reviewing their own experience vis-à-vis other transition countries and in drawing valuable lessons for the future. They also welcomed the opportunity to exchange ideas with CIS-7 counterparts, academics, and IFI representatives. Some delegations expressed frustration with the lack of practical results from the Initiative, especially regarding specific solutions to the debt problem. All agreed that there was still much to do to complete the transition process and to reduce poverty, but were broadly optimistic about the future. This position is clearly

13 influenced by the pickup in growth during the last couple of years, which has already translated into some improvement in living standards. IV. NEXT STEPS FOR THE IFIS 24. The IFIs work program in the period ahead corresponds closely to the priority areas identified in the Lucerne Conference. Encourage strengthened ownership and implementation of reform programs, and governance 25. The IFIs will continue to help countries design and implement their reform programs. Given the advanced stage of the PRSP document in most of the countries, efforts will increasingly focus on the implementation and monitoring of these programs, with a special emphasis on prioritization and costing of reforms. This will require a close linkage of the PRSP with the annual budgetary process and the medium-term economic frameworks. Another PRSP Forum is planned in about a year s time to bring together the national PRSP teams and enable a free exchange of views on how to advance the PRSP process. 26. Efforts to further improve governance will focus on public expenditure management, transparency, civil service accountability, and follow up on the BEEPS. The IMF and WB will continue to devote significant technical and financial assistance to the strengthening of national systems of public expenditure management, including the prudent management of natural resource wealth where applicable. Efforts to improve public expenditure management will also focus on identifying and making transparent quasi-fiscal operations, especially in the energy sector work on cross-subsidization in the energy sector in Azerbaijan is already underway and the EBRD has projects in a number of countries designed to improve cost recovery levels in the energy sector. Governance issues are a key focus in adjustment loans under preparation by the World Bank in Armenia and the Kyrgyz Republic. Capacity building to improve design and implementation of reforms 27. Capacity building will continue both in the context of regular technical assistance to individual countries, as well as through additional regional workshops. In addition to trade issues (see below), a number of additional capacity-building events targeting senior government officials involved in policy implementation are already at an advanced stage of preparation: a CIS-7 workshop on financial sector issues, in Bishkek in May 2003, led by the IMF; a CIS-7 workshop on social sector issues planned in June 2003, led by the World Bank; a CIS workshop on regional tax issues, in Kiev in July 2003, led by the IMF;

14 a CIS-7 workshop on public expenditure policy and management, in September 2003, led by the World Bank. Financial assistance 28. The IFIs will continue to provide financial assistance in the context of ongoing programs. As noted above, six of the seven countries have PRGF arrangements with the IMF. Assistance from the World Bank, ADB, and EBRD will be driven by the approved Country Assistance Strategies that reflect the reform priorities agreed with the country authorities and which provide the modalities for extending support to both the state and the private sector. While the primary aim of these programs is to support sustained economic growth to increase welfare and reduce poverty, improved growth prospects will also help debt sustainability. 29. In addition, bilateral creditors will play a key role in ensuring continued progress towards sustainable debt positions. Given the still fragile debt positions of many of the countries, a high grant element in new commitments would be desirable. Additional commitments from both Paris Club and other creditors are likely to be needed for some countries. Regional cooperation 30. Finding a resolution to the regional trade disputes is a high priority for ensuring that recent growth rates can be sustained. While country representatives acknowledge the importance of this issue, there are clearly problems in implementation on the ground. Problems in the Caucasus appear rooted in the political situation over Nagorno-Karabakh and tensions in Georgian-Russian relations. In Central Asia, the issue appears to be a general lack of commitment to free trade, particularly in Uzbekistan, as well as the political strength of vested interests. Recent anti-trade measures introduced by Uzbekistan and the unofficial taxation of transit trade in Kazakhstan clearly constrain the growth potential of the Kyrgyz Republic and Tajikistan. 31. The IFIs are pursuing a closely coordinated agenda to advance regional cooperation. The EBRD annual meetings scheduled to be held in Tashkent during May 4 5, 2003, will highlight trade and water issues and provide opportunities for furthering business development in the region. Regional trade cooperation will be taken up at a senior level during a conference in Bishkek on May 10, The ADB will host a further Ministerial meeting on regional cooperation in Tashkent in October. 32. There are also concerns surrounding access by the CIS-7 to industrial country markets, particularly the EU, and farm subsidies provided by industrial countries. Concerns are heightened by the fear of disruptions of traditional trade patterns following EU enlargement. The WTO accession process has provided a framework for trade reform that is likely to result in more predictable market access, and the Doha round of multilateral trade

15 negotiations may improve matters in export sectors of particular interest, including agriculture. V. CONCLUDING REMARKS 33. Initial results from the first year of the Initiative have been promising. Most of the countries have made significant advances in designing and implementing comprehensive programs in the context of the PRGF/PRSP process, and that process is providing a useful framework for coordinating donor support. 34. Progress has also been made in addressing the debt issue, albeit at a slower pace than hoped for by some participants. Paris Club reschedulings for Georgia and the Kyrgyz Republic provided valuable cash-flow relief in these countries. Bilateral reschedulings notably the agreements between Russia and Armenia, and the agreements signed by Kazakhstan, Russia, and Uzbekistan with Tajikistan have also provided essential relief. Fiscal positions in the region have also generally improved. Nonetheless, debt burdens remain high in some countries. 35. From the perspective of the participating IFIs, the Initiative has provided an umbrella for enhanced cooperation. The Lucerne Conference and the regional activities under the Initiative including the work on trade cooperation and the planned series of workshops as well as the PRSP process in the individual countries have all involved input from each of the four IFIs. 36. Although understanding of trade issues is increasing due to the extensive in-depth analytical work, concrete results have been less visible in this area. Improving regional cooperation to facilitate rather than prevent transit trade is key to unlocking the growth potential of the countries. Access to the EU and other industrial country markets is also a pressing issue. 37. Doubtless, the CIS-7 will continue to share many common issues for years to come. However, given the growing divergence of policies and performance and the increasing importance of issues involving only a subset of the countries, it will be useful to re-examine the benefits of grouping all seven countries under the same Initiative. The modalities under which this Initiative could be continued will be carefully reviewed, with a view to drawing conclusions at a meeting of CIS-7 and donor governments and IFIs in the spring of 2004.