On the verge of crisis: the treatment of Tajik economy will not be easy

 

 “The increasing recession in Tajik economy, the depreciation of the national currency and the threat of budget deficits require urgent and adequate measures by the government”, said Konstantin Bondarenko, an economist, head of the PA “Center for free market of Tajikistan”, in an article written for cabar.asia.

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Do not expect that the economic growth will be fully restored in Tajikistan in the short-term. The scenario of what will happen depends on the effectiveness of the decisions made. The most likely options are either some mitigation of economic shocks and quite a long recession, or a serious economic crisis.

 

 

Recently, the word “crisis” has become one of the most used in the lexicon of Tajik entrepreneurs, migrant workers and even housewives.

 

The year of 2014 was a turning point, revealing the full extent of the Tajik economy depending on external factors and not ready for the challenges. The long accumulated problems in the stagnating Russian economy were supplemented by a sharp drop in oil prices and economic sanctions last year. Tajikistan, a significant portion of the  working age population of which are in labor migration and provide infusion into the Tajik economy at a level comparable to almost half of GDP, of course, got affected by Russia’s problems.

 

The situation has worsened not only because of the reduction in real incomes of migrant workers due to the sharp depreciation of the ruble and the unfavorable economic situation in Russia, but also due to the introduction in the Russian Federation of the new rules of stay of foreign workers. Mandatory patent and health insurance, supplemented by the requirements to pass exams in Russian language, history, basics of state and law of Russia, have considerably reduced the attractiveness of work in the migration. Many Tajiks voluntarily returned home. The number of people deported from the Russian Federation because of the violations of immigration law has also reduced.

 

By the end of 2014, according to the National Bank of Tajikistan (NBT), the volume of remittances to Tajikistan had decreased by 8.3% compared with 2013. Forecasts for remittances in 2015 are much more pessimistic. Thus, according to the estimates of the International Monetary Fund, their volume will be reduced in the current year to 30% of the level in 2014. In connection with the reduction of the flow of foreign currency into the country, the somoni began to rapidly fall.

 

It was immediately followed by a rise in prices for consumer goods. Although the official statistics say about the inflation rate of 2.2% since the beginning of the year (data of the NBT), the methodology of its calculation reflects the change in prices of a very large list of goods. However, for the average consumer, of real importance is the change in prices, first of all, of the essential commodities, among which food is the most important. Today we can affirm that the price of imported food increased by an average of not less than 20% since the beginning of the year.

 

Reduced remittances and rising prices for goods have influenced the consumer demand. Households that earlier spent their money not only for food but also for the purchase of clothing, household appliances, building materials and even entertainment are now forced to adjust their spending and save more. This fact, as well as problems in the foreign exchange market, has led to a reduction in imports of goods. Official figures show the decline in imports by 17% in the first quarter of 2015. According to some unofficial estimates, this decline is much higher in reality, and in many customs checkpoints, the movement of goods has virtually ceased.

 

The reduction of customs duties, which account for almost half of the budget, has led to the first in recent years failure of the plan for the collection of taxes. According to the statements of the Ministry of Finance of the Republic of Tajikistan, the state budget made 95.6% of the plan in the first quarter of 2015.

 

Despite the apparent decline in many of the indicators, as a whole, according to official statistics, the Tajik economy still shows growth. In the first quarter of this year, it amounted to 5.3%. This indicator is quite satisfactory, but it is lower than in the corresponding period last year (when the increase was 7%). The International Monetary Fund, the World Bank, the Asian Development Bank and the European Bank for Reconstruction and Development are giving a very discreet outlook on the prospects of economic growth in Tajikistan. According to the data presented in the Economic Survey of Tajikistan, published by the German Society for International Cooperation (GIZ, Economic Survey of Tajikistan, №4, 2015), the so-called “consensus forecast”, i.e. the average value of the individual forecasts of the aforementioned international organizations, is 3.65% growth. If this forecast comes true, the growth of the Tajik economy in the current year will be less than during the post-crisis year of 2009 (when it was 3.9%).

 

In fairness, it is worth noting that the situation taking place in the Tajik economy is still too early to call “crisis”. The economic crisis is characterized by a sharp violation of the existing balance; it is the apogee of the imbalances in economic indicators. During the crisis, there is a sharp decline in industrial production, the accumulation of unsold goods on the market, the fall in prices, the collapse of the system of mutual settlements, the collapse of the banking system, a wave of bankruptcies and a sharp increase in unemployment.

 

Fortunately, all these elements together are not observed in Tajikistan today. However, the symptoms of growing problems are already evident. Markets of industrial goods and building materials that used to be crowded in the past are gradually becoming empty. Prices continue to rise, those wanting to purchase goods are few, and many entrepreneurs do not buy new batches of products.

 

The alarming situation is in the construction sector that has previously demonstrated a record growth rate. According to the International Finance Corporation (the report “Regional Economic Outlook: Central Asia and Tajikistan”, December 2014), the construction sector was the major component of GDP growth in Tajikistan in 2014 (3.4% of the total growth of 6.7%). At the end of the first quarter of this year, the construction sector demonstrates the growth of just 0.9% compared with a jump of 38.1% in the same period in 2014.

 

Prices of real estate have slightly reduced, but their collapse has not yet happened. Nevertheless, the demand for real estate has fallen markedly. With a further reduction in demand, prices will inevitably continue to decline. The companies, which invested their own funds in the construction, will possibly wait out unfavorable times. But those who accounted for the sustained high prices and demand and took loans will most likely to go bankrupt by the fall of this year.

 

Obviously, this will affect the stability of many banks and other sectors of the economy. Thus, the former growth engine could become one of the generators of the economic crisis.

 

Of particular attention is the banking sector. The growing problems in all other spheres will, anyway, affect the financial services sector. This topic requires a separate analysis, but it should be noted that many of the problems of banks did not appear yesterday. They grew gradually. The margin of banks and other financial indicators of the banking system have been deteriorating since 2005. Not less objective cause of the problems is the intervention of the government, forcing to generously fund its programs. Thus, the overall stability of the banking system to shocks is reduced, and the risks are growing.

 

As a result, Tajikistan is quite close to the point where additional deterioration caused by external factors cannot be neutralized by the economy with the accumulated ballast of internal problems, and a relatively gradual economic slowdown risks to escalate into a major crisis.

 

Unfortunately, oddly enough, not only external factors, but also the anti-crisis measures taken by now in the country can contribute to the deterioration of the situation. Since the government, apparently, is not going to show any anti-crisis plan to the public, only some practical indicators can give some hint to the public about the measures undertaken.

 

The main factor, creating additional risks, is the administrative pressure on the currency market and fiscal issues.

 

The National Bank of Tajikistan reacted to the fall of somoni by currency interventions, which led to a decrease in its reserves. Then it moved on to more drastic measures. So, on April 16, 2015, the NBT issued a resolution which stopped the activities of private money exchange offices, the number of which at the time was more than half of the total number of exchange offices in the country (818 of 1581). While, as a result, some closed exchange offices were re-registered as credit institutions, this measure was an additional blow to the foreign exchange market and failed to stop the fall of the national currency.

 

In addition, the measures taken by the NBT restrict the sale of currency to the population.  The former leadership of the National Bank was dismissed. In its first statement, the new leadership of the NBT reports about the “average dollar exchange rate remains stable”.

 

This brings to mind an anecdote about “the average temperature in the hospital”. Indeed, during some period of time in May, the exchange rate did not change, but the problem is that it is virtually impossible to buy dollars at specified rates.

 

As a result of these “anti-crisis” measures, for the first time in many years, a “black” currency market begins to form in Tajikistan”, where one can buy dollars at a much higher exchange rate. Since the end of April – early May, the value of one dollar was at least 6, 8 somoni, while the exchange rate of the NBT was 6, 25 somoni per dollar.

 

The country dependent on imports needs dollars at least to buy necessary goods abroad. And if it becomes very difficult to buy the dollar, it is easy to assume that the volume of imports will continue to fall. This, in turn, has a negative impact on revenues in the budget.

 

Entrepreneurs take into account the real market, or rather the “black market” exchange rate of foreign currency, and this leads to further rise in prices for consumer goods. Administrative pressure has also led to a decrease in the number of transactions that were previously held in foreign currency – purchase/sale of automobiles, real estate and others.

 

Another popular measure to combat the economic recession in Tajikistan is the activity of the fiscal authorities. The frequency of tax audits has increased, entrepreneurs are forced to finance new initiatives for “voluntary” funding of road maintenance and other “timely” projects. The actions of the government are no longer limited to tough collection of real or alleged indebtedness and “contributions”. Major taxes are also growing.

 

A striking example is the increase in the excise tax rate to 5% for all types of telecommunications services from April 2015 (cellular, Internet and others.). The industry, which has already been a “cash cow” for the budget over the past years, was used again. If one looks at the indicators of the industry revenue, it is possible to see that 15% growth in the period from 2011 to 2013, was replaced by the sluggish 1.2% per year in 2014 (data of the communication services under the Government of the Republic of Tajikistan). In 2015, we can confidently expect a stagnation or even a fall of revenues in this industry, which was one of the most dynamic, stimulating the creation of thousands of jobs and among the top five in terms of attracting foreign investment.

 

Smaller entrepreneurs did not remain unaffected either. The social tax rate for individual entrepreneurs has also increased. Taxation of individual entrepreneurs operating under the certificate (especially in the regions) has become semi-arbitrary. Since many entrepreneurs for various reasons do not keep detailed records of income, they either guesstimate the turnover tax they have to pay, most often it depends on how they arrange it with local tax offices. And now, when there are problems with the implementation of the plan to collect taxes, they are required to inflate the declared income to pay taxes “in advance” for a few months, etc.

 

No matter how well-intentioned such actions are, relying on the “squeezing” of taxes and intensive audits could lead to temporary filling of specific gaps in the budget, but not to long-term positive effects.

 

The struggle with the consequences of problems, rather than with their real causes, by rigid command and administrative measures may create a short-lived illusion that “everything is under control”, but in fact, it can lead to the withdrawal of resources from efficient enterprises and will increase the share of the shadow economy. This may result in a general decline in economic activity and, as a consequence, the fall of the same budget revenues for which government officials are now struggling. In addition, the time so necessary for economic recovery will be lost.

 

Government spending: cut the coat according to the cloth

 

Public expenditure is one of the key factors mitigating or deepening economic recession in Tajikistan. However, keeping them at the same level or even their increasing will not lead to the restoration of the Tajik economy, on the contrary, it will lead to its “exsanguination”.

 

One can understand the complexity of the cuts in social spending (although some countries do it) – it has a direct impact of the income of many social groups, and there is nothing to compensate them in the short term. Nevertheless, the expense of another nature remains very considerable – first of all, various major government projects – construction of the “anniversary” and other demonstration sites.

 

The logic of escalating costs during a recession is quite simple. The government expects that the implementation of various large-scale projects, at least in the short term, can create jobs and generate some income for the population. These gains, in turn, are spent on consumption, i.e. support the falling demand for goods and services, businessmen continue to get the necessary working capital, and the economic “blood circulation” is restored. And then, probably, the external environment will change – the income of migrants will return to previous levels or prices for the main export commodities will rise. Public spending should play the role of an “injection” animating the economy. The logic is really simple, but by no means unambiguous.

 

Such actions were at one time the main economic policies of US President Roosevelt during the Great Depression in the 1930s. Despite the lack of evidence of the effectiveness of these measures, there is a certain myth of the miracle of public spending to this day.

 

However, the economic logic in this case prompts a different scenario. Thus, the increase or maintenance costs at the same level, designed for stable growing budget revenues, would seriously undermine the economic potential of the enterprises that continue to operate in difficult economic conditions.

 

As the main source of public expenditure is the budget, before spending money, it must be collected. Do not expect a marked increase in international aid, or a substantial investment from partner countries. International assistance can be really attracted by large-scale reforms to improve the investment climate, and not for some dubious construction projects of new cities or large buildings. Investment is also usually directed to mutually beneficial infrastructure projects, rather than stimulating therapy, such as “just to build something.”

 

Therefore, the only available source of funding for government spending remain taxes. And given the decline in imports, it is not the customs duties, but the taxes on income of enterprises operating in Tajikistan.

 

But the problem is that during the recession, most companies need a free capital. Taxes and all sorts of unofficial payments significantly reduce it. As a result, even those companies that have a margin of stability begin to experience difficulties. In the absence of free capital, they will have to reduce turnover, which in turn will lead to a reduction in the level of wages, dismissal of the workers, and other consequences. When increasing tax and other financial burden, less stable businesses are most likely to simply go bankrupt.

 

The resources that will be collected to create hundreds or even thousands of artificial and temporary jobs will eventually lead to the loss of tens of thousands of existing ones that create real economic value of other jobs, so far paid. Thus, no constructive effect will take place, and precious resources in the pre-crisis period will be reallocated from efficient enterprises in favor of less efficient ones.

 

Therefore, measures to mitigate the effects of the economic downturn should not be directed at stimulating the activity at the expense of the redistribution of resources, but for preservation of the stability of existing businesses.

 

The best anti-crisis benchmark should be a wise proverb – “cut the coat according to the cloth”.

 

All expenses of not directly social nature should be radically reduced as soon as possible. Construction projects of national symbols, new towns, entertainment complexes and many others should be frozen if they have been started, or even refused in implementation, if they are still only “on paper”.

 

Cuts in public spending will help have a balanced budget even in a situation of falling incomes of the enterprises and thus lower tax revenues. It is an effective short-term measure, which will help many efficient companies to survive.

 

Further steps should be getting rid of the existing economic ballast.

 

 

Despite a more than 20-year history of privatization in Tajikistan, there are still many state-owned enterprises.

 

If, in some cases, when it comes to the Tajik aluminum company or companies of the energy sector, there may be some risks accompany privatization, in other cases, there are not any rational economic arguments against the sale of state-owned enterprises.

 

Imperfect mechanisms for accounting, management and accountability of public enterprises, lead to both financial losses and the emergence of the so-called “contingent fiscal risks”, the effect of which may come at any moment. In addition, the work of many state enterprises creates a distorting effect on competition, pricing and other market-based mechanisms. Giving limited resources for their own existence, state-owned enterprises absorb more benefits than create.

 

If the sale of state-owned enterprises is held on a transparent scheme, it will attract additional funding in the budget, and more effectively managed enterprises will become attractive for investment and will pay more taxes. But even with “non-transparent” privatization when enterprises may be sold below the market price, they at least, they will cease to be a ballast for the national economy.

 

In the medium term, privatization is a justified and effective solution that may lead to the release of the above mentioned and much-needed resources and to increase in the competitive potential of the overall economic recovery.

 

 

What to do with the deteriorating situation on the labor market? During the recession, no one is rushing to create new jobs. Migrants returning in thousands can worsen the already difficult social situation, if they are not employed.

 

If we eliminate costly and inefficient measures mentioned above, the government has an obvious choice to support small business. We are not talking about grants or concessional loans, because it just creates additional risks and has fairly negative precedents.

 

It is necessary first to change the regime of regulation and taxation of such a segment as individual entrepreneurs.

 

In Tajikistan, it is necessary to take into account the actual level of financial and legal literacy of the population. The patent system is the easiest way to legalize the huge number of entrepreneurs and give them opportunity to ensure their livelihoods. This measure is able to positively affect the employment of citizens with some professional experience and the desire for self-employment returning from migration.

 

Moreover, the changes in taxation for groups of taxpayers with an annual gross income of less than 500 thousand somoni (under the so-called “simplified” tax system) have no strategic fiscal importance, i.e. budget revenue only slightly dependent on the tax by individual entrepreneurs. Thus, the main objective of tax policy in the micro and small business should be the employment, but not the revenues. The number of taxpayers in this sector is very large – several tens of thousands of people, and with a stimulating approach – hundreds of thousands, who, in turn, provide means for living for some of their family members, i.e. it is a very socially significant segment of the economy.

 

Therefore, in order to stimulate the development of small business, an effective decision that does not require investment of time and resources is to adopt the new rules of taxation for individual entrepreneurs. It is necessary to expand the list of activities that can be carried out on the basis of a patent.

A more radical measure can be taken, too, – abolishing sole proprietorship based on possession of a certificate as an organizational-legal form and moving to the systems of patents; and all those who, in fact, work in the format of an enterprise should be moved to the form of a Limited Liability Company.

 

Finally, the next important step towards supporting small, medium-sized and large businesses may be a new moratorium on inspections of businesses.

 

Most of the proposed anti-crisis measures in the article have more to do with a set of short-term measures. However, they are more important today, because their implementation does not require a long period of time to prepare or significant financial costs.

 

The implementation of the above measures can mitigate the effects of the growing recession in Tajikistan. These measures will also make it possible to implement other medium-term and long-term measures aimed at achieving sustainable economic growth.

 

After or simultaneously with the implementation of short-term measures, it will be necessary to carry out deep structural reforms in all spheres of public administration and management. In the medium term, it is necessary to revisit the issue of reducing the tax burden and simplify tax administration, which was not done at the time of the adoption of the Tax Code in 2012.

 

Special attention should be paid to the development of the financial market, which long requires forming the stock market as an additional tool of transformation of domestic savings into investments.

 

In general, the prospects for the development of Tajikistan’s economy is closely linked to the change of priority from the administrative model of the state as the main investor, often acting at non-market motives, to the development of the internal potential of entrepreneurship. Only in this way, the diversification of the economy and its resilience to external shocks can be achieved.